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Financial Intermediation, Investment and Economic Growth in Nigeria 41

1 The authors are grateful to the participants at the Centre for Econometric and Allied Research (CEAR),University of Ibadan, seminar series and that of the African Econometric Society (AES) Conference inKampala, Uganda for their helpful comments and suggestions.

* Department of Economics, University of Ibadan, Ibadan, Nigeria, E-mail: [email protected]** Department of Accounting, Banking and Finance, Osun State University,, Osogbo, Nigeria.

Asian-African Journal of Economics and Econometrics, Vol. 14, No. 1, 2014: 41-55

FINANCIAL INTERMEDIATION, INVESTMENTAND ECONOMIC GROWTH IN NIGERIA:

A SIMULTANEOUS EQUATIONS APPROACH1

Adegoke Ibrahim Adeleke* and Abraham O. Gbadebo**

ABSTRACT

This study examines the interrelationship between financial intermediation, investment andeconomic growth in Nigeria. It developed a small macro-econometric model that is based onthree stage least squareestimation technique. The results show that financial intermediationthatis decomposed into banking and non-banking sectors has a positive linkage effects on growththrough the investment channels and this is consistent with existing studies. Therefore, the papersuggests thatpolicymakerthat is desirous of stimulating investment and thus economic growthmust adopt appropriate mix of regulatory, fiscal and monetary policies that will enhance efficientfinancial intermediation.

Keywords: Financial Intermediation, Growth, Investment, Three Stage Least Square

JEL Classification: E44, O16, C32

1. INTRODUCTION

Over the years, the linkages between financial intermediation and economic growth havegenerated a lot of attentions among policymakers, practitioners and public commentators aroundthe globe. Several economic literatures have identified different channels by which efficientand effective financial intermediation can impact on economic growth. One of such viewsfocuses on the key functions of financial systems in the saving-investment-growth nexus. Bychannelling funds from surplus to deficit units, mobilizing resources and ensuring an efficienttransformation of funds into real productive capital.

Despite the existence of growing literature on the roles played by financial intermediarieson economic growth, theoretical and empirical works on the subject is yet to produce aconsensus. Two major trends are prominent in the literature. The first argues that financialintermediaries increase the amount of funds available for investment by pooling savings andfacilitate technological innovation. This argument centres on their ability to allocate savingsmore effectively by gathering savings, evaluating investment projects, monitoring managers

42 Adegoke Ibrahim Adeleke and Abraham O. Gbadebo

and facilitating transactions at lower cost1. The major reasoning of this line of argument is thatactual saving and investment rates are higher in countries that have more developed financialintermediations.

The other strand of the literature points to a number of drawbacks and weaknesses ofnational financial intermediaries in their ability to enhance growth, particularly in the developingcountries that is characterised by weak corporate governance, low income, savings andinvestment. They contend that financial intermediaries may be tempted to extract rent from theinformation collected on prospective investment projects, thus reducing the payoff that accruesto firms. This may reduce the efforts by firms to undertake innovative activities and investmentEven a close relationship between intermediaries and firms may prevent competition in creditmarkets and reduce intermediaries’ ability to enforce efficiency in corporate governance. Someother studies have also shown that while close intermediaries-firm relationships may facilitateaccess to capital, they do not necessarily reduce the cost of capital nor do they increaseinvestment (Rajan 1992; Weinstein and Yafeh 1998; Morck and Nakamura, 1999 among others).

Therefore, the growing empirical evidence has generally found mixed results betweenfinancial intermediation and economic growth. These conflicting findings can be partly attributedto different sets of econometrics methodologies adopted in such empirical studies (such assingle equation Ordinary Least Square, Granger Causality, Correlation Analysis, Panel DataAnalysis among others). The current study seek to improves on the previous studies by estimatinga three stage least square (3SLS) regression framework, which overcome the simultaneity biasusually associated with the use of ordinary least squares in a framework where the right handside (RHS) endogenous variables are correlated with error term thereby resulting in misleadinginferences. In this wise, we specify a small structural macro-econometric model tosimultaneously examine the effects of financial intermediation variables on aggregate domesticinvestment and economic growth. Another innovation in this study is that itanalyzes the impactsof financial intermediation on economic growth in Nigeria as against cross country studieswhich frequently sample very different economies and the resulting significant impact offinancial intermediation on economic growth may partly be driven by excessively heterogeneoussamples2.

The questions practitioners and policymakers seek to discover is whether nationalfinancial markets still matter for growth once domestic agents have access to foreign markets,sometimes at a reduced cost of capital. This paper seeks to examine the relevance of financialintermediation in Nigerian economy, giventhe increasingly integrated financial market.Specifically, it examines the impact of banking and non-banks financial institutions on thelevel of investment in Nigeria, from 1970 to 2010. It will also evaluate the relationshipbetween financial intermediation and economic growth by testing whether financialintermediation variables really have statistical significant effects on aggregate domesticinvestment andeconomic growth in Nigeria using a new and improved methodology. Researchwhich enhances a better and deeper understanding of this interrelationship will, therefore,play an invaluable role in ensuring coherence and mutually reinforcing measures that notonly promote the development of financial system in Nigeria but also ensure macroeconomicstability in the context of sustainable growth.


Following this introductory section, the paper is structured into six main sections. Section2 discusses stylized facts on the nexus between financial intermediation and economic growthin Nigeria. Section 3 provides a brief review of the existing literature both at the theoreticaland empirical level. Section 4 addresses the theoretical framework and methodology of thestudy while section 5 presents and discusses the empirical results. The last section of the paperconcludes with some policy implications.

2. STYLISED FACTS ON FINANCIAL INTERMEDIATION AND ECONOMICGROWTH IN NIGERIA

In Nigeria like many other countries of the world, the issue of financial intermediation involvesa lot of institutions. These institutions will be divided into two major groups, viz; the regulatoryinstitutions and the facilitators or players. The regulatory bodies are: The Central Bank of Nigeria(CBN), Nigeria Deposit Insurance Corporation (NDIC), Securities and Exchange Commission(SEC), National Insurance Commission (NIACOM), National Pension Commission (PENCOM).While the players are: the Deposit Money Banks (DMBs), Discount Houses, DevelopmentFinancial Institutions, Community Bank/Microfinance Banks, Bureaux-de-Change (BDCs)Finance Companies, Insurance Companies, Pension Funds Administrators and Custodians, StockBroking Firms etc (Mordi et al., 2010).

DMBs are usually the obvious big players in this process and they perform intermediationfunctions by mobilising inactive resources and directing such resources to productive activitieswithin an economy. In other words, the resources are channelled from the surplus segments ofthe economy to the deficit sectors thus ensuring a more proficient resource distribution andutilisation. Prior to the introduction of universal banking system in 2001which allow DMBs tochoose the segment of the financial market they wish to operate, commercial banks are at theretail end of the market where the small and medium savings are mobilised and disbursed inform of loans and advances.

Figure 1 shows the trend of credit granted to the private sector by Deposit Money Bank andby other non-financial institutions as a percentage of GDP. A critical examination of the trendindicates that DMBs dominate in the process of credit allocation in form of loans and advances.

Figure 1: Analysis of Private Credits by DMBs and Other Financial Institutions, 1981-2010

Source: CBN Statistical Bulletin (2010)


This shows the reasons why non bank financial institutions are called secondary money creators.This is contrary to what is obtainable in some advanced economies where non-bank financialinstitutions contribute more significantly in the process of financial intermediation.

Another way of analysing the impact of financial intermediation on investment and growthis through the payment structure. Payment system is the institutions, instruments, proceduresand information and communication arrangement; which offers the channel for transfer ofmoney/financial assets in settlement of financial debt. An efficient payment structure is essentialfor smooth functioning of financial system. It reduces the risk inherent in financial arrangementincluding those of liquidity, settlement, systemic, credit and operational risks. In addition itcondenses transaction cost, improves efficient intermediation and sustains the globalcompetitiveness of an economy. It checkmates the amount of float in the system that obstructseffectiveness of monetary policy and alters monetary data. Therefore, efficient payment systemsensure channelling of funds from surplus to deficit units and guarantee an efficienttransformation of funds into real productive investment and thus bringing about growth.

Table I shows the development in major financial intermediation indicators from 1981 to2010. One of the major ways of examining the cost of intermediation and thus the efficiency offinancial intermediation is through the structure of interest rates. While the short term rates forsavings are going down, the rates for bank loans and loans for term lending remained high andsticky as a result of the high cost of funds mobilised by banks. Following the deregulation ofinterest rate in the post SAP era, the spread between deposit and lending rates begin to widenand thus, interest rates increased remarkably. The high interest rate implies that costs ofborrowing have gone up in the organised financial market, thereby increasing the cost ofoperations. However, a measure of distortions in the money market is the increasing divergencebetween the lending rate and the deposit rate otherwise known as the interest rate spread. Thespread rose from 3.33% in 1986-1990 periods to 10.62% in 1996-2000 and a height of 15.56%in 2001-2005. This spread has since decline slightly to 10.74%. The impact of these distortionsin the money market hinders efficiency and competitiveness of the financial sector withconsequent negative impact on the real sector of the economy.

Table IDevelopments in Major Financial Intermediation Indicators (1981-2010)

Year Interest Liquid Private Sector Private Credit Bank Deposit/ Growth RateRate Liability/ Credit by by Other GDP (%) of GDP

Spread GDP (%) Deposit Money Financial (%)Bank/GDP Institutions/

(%) GDP (%)

1981-1985 7.72 29.72 15.41 0.23. 20.56 -0.331986-1990 3.33 22.72 10.57 0.11 15.95 5.981991-1995 7.04 21.56 10.44 0.09 13.89 1.021996-2000 10.62 15.95 11.86 0.12 10.82 3.22001-2005 15.56 20.36 12.02 0.11 14.64 6.082006-2010 10.74 22.24 22.41 0.12 19.21 6.66

Source: World Bank Financial Structure Database (2009), CBN Statistical Bulletin (2010) and Annual Reports (variousissues)


The sharp swing in the liquidity, from an abundance of liquidity to the acute shortage ofliquidity is one of the major distortions that have been experienced. One of the major reasonsfor the observed trend is overdependence of DMBs on public sector funds. This made them toignore their primary intermediation function of savings mobilisation and inculcation of bankinghabit at both household and enterprise levels. The repercussions were fragile and unstableresource base, high operation cost, and subjection of their activities to dwindling governmentincome due to fluctuation in international oil market. The apparent consequence of swings inliquidity is seen in increased uncertainty for both the purveyors of institutional credits andproductive enterprises seeking credit.

Similarly, it is clear from the table that the liquidity liability, DMBs credit to the economyand bank deposit as a percentage of GDP declines consistently throughout the periods of 1981to 2000. This phenomenon is expected to have adverse impact on investment and consequentlythe economy. Generally, financial intermediation measures are on decline since the liberalisationof financial system in 1986, except in more recent period when some of these measures beginto improve. Therefore, this interrelationship is not a straight forward and in addition to thisvisual inspection, the study carried out an empirical investigation to ascertain the exactinterrelationship between financial intermediation, investment and economic growth in Nigeria.

3. REVIEW OF THE RELEVANT LITERATURE

There are several theoretical propositions on the linkage between financial intermediation andeconomic growth in the economic literature. The importance of financial intermediation in theeconomy can be better understood by examining the different functions financial intermediariesperform. They provide payment arrangements for an economy and this is germane for the smoothrunning of the system. This includes liquidity, settlement, systemic, credit and operational risks.Effective payment system also reduces transaction costs and supports global competitivenessof an economy.

Modern theories of financial intermediation focus on information gathering, transactioncosts and regulatory factors. These theories are based on the idea that information irregularitiesmay lead to adverse selection, moral hazard and costly monitoring for the ex-ante, interim andpost-ante respectively. Financial intermediaries are able to repress most of the inadequacies inform of transaction costs to some extent. In these theories, financial intermediaries are perceivedas information spreading associations, surrogate observers for the definitive investors, leaguethat offer domestic savers with insurance against personal tremor that may negatively distorttheir liquidity state of affairs (Leland and Pyle, 1977; Diamond, 1984; Diamond and Dybvig,1983). A recent and more detailed textbook treatment of the theory of financial intermediationis presented in Scholtens and Wensveen (2003).

Based on these theoretical proposition and others, the empirical literature has witnesseddifferent contributions over the years, a recent survey is contained in Badun, (2009). Thesestudies have employed different methodologies (such as cross-country regression, time seriesanalysis, panel data analysis and only relatively few studies use instrumental variable estimatorapproaches) in examining the linkage between financial intermediation and economic growth.However, empirical evidence provided by these studies has been mixed, and a consensus has


not yet emerged. For instance,Bhatia and Khatkhate (1975) use correlation analysis to explainthe linkage between economic growth and financial intermediation for eleven African countries.Financial intermediation variables used are: the ratio of currency, demand deposits and timeand savings deposits each as a ration of GDP. They find no relationship between growth andfinancial intermediation for the countries that they investigated, either individually or for thewhole group. Even when they divided the financial intermediation estimates into two: ratio ofmoney to GDP and the ratio of quasi money to GPD yet their result reveal no definite relationshipbetween growth and financial intermediation.

Similarly, De Gregorio and Guidotti (1995) showed that in the sample of Latin Americancountries there is a robust and significant negative relationship between financial intermediationand economic growth. They explain this correlation with the fact that in the absence of properregulation, more financial development may be linked with a lower efficiency of investment.They concluded that the positive relationship between financial intermediation and economicgrowth may be reversed in the presence of unregulated financial liberalisation and expectationsof government bailouts. However, all of them are not statistically significant and offer nosupport to growth enhancing capabilities of financial intermediation.

However, King and Levine (1993a, b) used four measures of financial system: ratio ofliquid liability of financial system to GDP, quantum of credit provided to the private sector toGDP, share of total domestic credit provided by banks and share of total credit allocated toprivate non-financial firms. The first two measured the quantity of financial activities in theeconomy while the last two the quality of financial activities. They also made use of threemeasures of economic growth namely: per capita growth rate in GDP, per capita growth rate incapital stock and total factor productivity rate. They applied simple correlation method. Theyalso made use of leads and lags as in case there is no contemporaneous links between financialdevelopment and economic growth. Their findings reveal that data are consistent and financialservices stimulate economic growth when rate of capital accumulation is increased andimprovement of efficient capital utilization by the economies.

Levine, Loayza, and Beck (2000) examinedthe relationship between financial intermediationand economic growth from another perspective. Their study seeks to establish the shock of theendogenous component of financial intermediation on economic growth. A robust methodology,which made use of two models and two estimation techniques, was utilised. The first model,which defines economic growth as function of finance indicators and a vector of economicgrowth determinants, was estimated using the pure cross-sectional estimation technique. Thesecond model makes use of a dynamic panel model and for its estimation it uses the GeneralizedMethods of Moments (GMM). Both tests confirm the strong positive relationship between theendogenous components of financial intermediation and economic growth. They, however,observed that countries with main concern for creditors’ protection, strong-will to enforcecontracts, and appropriate accounting standards have the potential for a developed financialintermediation.

McCaig and Stengos (2005) introduced more active variables with a view to establishinga more dynamic empirical relationship between financial intermediation and economic growth.The study uses a cross-country analysis of 71 countries for the period 1960 to 1995. A linear


regression analysis, which defines economic growth as a function of financial intermediationand a set of taming variables, was estimated using the Generalized Method of Moments (GMM).The instrumental variable introduced includes; religious composition, years of independence,latitude, settlement mortality, and ethnic groups, three conditioning variables were alsoincorporated. These include; simple sets (initial GDP, and manpower development), the policyset (simple set, government size, inflation, black market premium, and ethnic diversity), andthe full set (simple set, policy set, number of revolution/ coup, number of assassination per1000 inhabitants, and trade openness). The study also supports the argument that a positiverelationship exist between financial intermediation and economic growth. However, it stressedthat this will be true if financial intermediation is measured by liquid liabilities and privatecredit as a ratio of GDP, while it will be weaker if it is measured by means of the Commercial-Central Bank ratio.

Hao (2006) seeks to establish the relationship between financial intermediation andeconomic growth, using a country-specific data from China. The study focused on the post-1978 reform period, using provincial data (28 Provinces) over the period 1985 to 1999. Thestudy employed linear model, which expresses economic growth as a function of its laggedvalues, financial development indicators (banks, savings, and loan-budget ratio), as well as aset of traditional growth determinants (population growth, education, and infrastructuraldevelopment). The study uses the one-step parameter estimates for the Generalized Method ofMoments (GMM) estimation and finds that financial intermediation has a causal linkage andpositive effect on growth through the channels of house-holds’ savings mobilization and thesubstitution of loans for state budget appropriations.

Some other authors such as Ogun (1986), Allen and Ndikumana (2000) and Aziakpono(2004) studied Sub Saharan African countries and used panel data to investigate the link betweenfinancial intermediation and growth.Ogun (1986) investigates the relationship between financialdeepening and economic growth using cross-section analysis for 20 countries in Africa over aperiod of 1969 and 1983. The degree of financial intermediation is proxy by ratio of monetaryliabilities (M1, M2 and M3) to GDP. For the full sample, all the monetary liabilities are negativeexcept the ratio of M3 to GDP which is statistically significant. When the countries are groupedinto high and low income countries some of the coefficients of the monetary liabilities arepositive.

Allen and Ndikumana (2000) employed the ratio of liquid liabilities, ratio of banks’ privatesector credit, and ratio of banks’ total credit as an index to include all the three variables asproxies for financial intermediation. They discover that only the ratio of liquid liabilities ispositive and statistically significant though it is insignificant in the fixed effects estimationand when annual data are used. The other financial intermediation measures take on differentsigns but all are insignificant. Aziakpono (2004) adopted the ratio of liquid liabilities and ratioof banks’ private credit as gauges of financial intermediation and discovered mixed results.Their findings reveal that economic growth and financial intermediation were negatively linkedin Botswana and Swaziland but the relationship in Lesotho and South Africa was positive. Theabove studies show that there is no clear cut relationship between economic growth and financialintermediation especially in the SSA countries.


A recent study by Shittu (2012) examines the relationship between financial intermediationand economic growth in Nigeria using single equation ordinary leastsquare method, from 1970to 2010. The paper made use of two financial intermediation measures: the ratio of broadmoney supply (M2) to Nominal Gross Domestic Product (NGDP) and ratio of domestic creditto private sector (CPS) to NGDP. The findings reveal that only one of the (broad moneysupply/M2) had a positive significant linkage with economic growth in Nigeria.

In sum, the empirical review above shows that financial intermediation can have bothbeneficial and detrimental outcomes on economic growth. The effects of financial intermediationon growth also differ across countries and regions, depending on the methodological approachesused in examining the relationship.Such divergences of results were quite wide in cases ofempirical studies which concentrated on estimation for individual countries.These conflictingfindings can be partly attributed to different sets of econometrics methodologies approaches insuch empirical studies. This study improves on these previous studies by estimating a smallstructural macro econometric model using 3SLS regression framework, which overcome boththe endogeneity and simultaneity bias that may lead to misleading inferences. The study alsoanalyses the impacts of financial intermediation on economic growth in a specific country(Nigeria) as against cross country studies which frequently sample very different economiesand the resulting significant impact of financial intermediation on economic growth may partlybe driven by excessively heterogeneous samples.

4. THEORETICAL FRAMEWORK AND METHODOLOGY

Following the theoretical literature review above we have modified the standard neoclassicalgrowth model in line with previous empirical studies (such as Zegeye, 1994; Webb et al, 2002among others) to include financial intermediation in the analytical framework. This revisionincorporates financial intermediation explicitly into the conventional growth model. The initialstep in the process is the specification of an explicit Cobb-Douglas production function of theusual form as follow;

Q(t) = A(t) K(t)� L(t)1–� 0 < � < 1 (1)

Where Q is the production at time t, K(t) and L(t) are measures of capital and labourservices at time t, while A explains changes in productivity of a given capital and labour due totechnology, which grows at the constant, exogenous rate g. So

A(t) = A(0)egt (2)Savings rates and/or other financial intermediation institutional factors have been identified

as pertinent factors in explaining differences in investment as well as productivity. Thesefactors are able to shift the production function outward in order to explain increases in nationaloutput. For this reason, we consider financial intermediation as a shift variable in our revisionto the standard growth framework. The aggregate financial activities make up a productivitymultiplicator in this revised model:

Z(t) = Z(0) exp [BANK(t) + OFI(t)] (3)Z(t) measures the aggregate financial activities of all financial institutions such as banks

(BANK) and other non-banks (OFI) at time t. Each financial activity is weighted by the size of


its monetary measure relative to output. Therefore, given these modificationsequation (1)becomes:

Q(t) = Z(t) A(t) K(t)� L(t)1–� (4)

This revised model predicts that financial intermediation spur capital stock productivity,in turn driving the level of investment and output. In this revised equation, Z(t) enters as alabour-augmenting and it is a multiplicative exponent that shifts the production function outward.In the case of financial intermediation, this shift presumably occurs because capital is directedtowards more productive activities, and new technology and/or organisational improvementsincrease output per labour unit. The assumption is that the economic impact of bank lendingand that of other financial intermediation in financing long-term projects is greater than thevalue of the amount financed, as this financing can facilitate an entire investment. Thisinvestment relates essentially to financial activity and not actual investment channelled.

Dividing equation (4) by AL, yields the intensive form of the growth equation,

q(t) = Z(t) k(t) (5)

An empirical specification of equation (5) is derived by taking natural logarithms andderivatives with respect to time. We have also included other conventional control variables(X) in the derivedgrowth equation as:

2

01 1

n

t i t t i t ti i

q µ Z k X� �

� � � � � � � � �� (6)

Where change in production intensity ( )tq� is the growth rate of GDP per capita. The change

in financial intermediary activity with respect to time is (Zt = �BANK + �OFI). The change in

capital intensity is ( )tk� is the gross domestic investment(computed as changes in gross fixed

capital formation). The variables included to control for other influences on productivity are(X

t) which is represented by human capital development (HCD) proxy by secondary school

enrolment, government expenditure as a share of GDP (GOVEXP), terms of trade (TOT) ismeasured as import plus export over GDP and initial GDP per capita. t = time indicator, i =1,2, 3 ... n, �

t = Error term.

Given the fact that relationship between financial intermediation and growth aresimultaneous in nature, single equation models used to estimate either of these variables are oflimited usefulness, as the explanatory variables would correlate with the error term and thusthe OLS will not give true estimates of the parameter, it would produce inconsistent andinefficient results.However, many empirical studies employing neoclassical frameworkcommonly ignore the potential endogenous relationship between these variables in theirestimations.

Therefore, this studyutilises a simultaneous equations rather than single equation approachin order to understand the full impact of the different financial intermediation variables onaggregate domestic investment and growth rate of output in Nigeria. The simultaneity in thepresent model arises from financial intermediation determining investment and itself determining


growth3. There is also the possibility that financial intermediation and investment might beendogenously related, thus the significance of financial intermediation could be obscured ordistorted if investment is included with it as a regressor in the same equation (See King andLevine 1993a and 1993b for more detail). Therefore, we follow this proposition and decided toremove measures of financial intermediation from equation (6) and this yields:

01

n

t t i t ti

q k X�

� � � � � � � �� (7)

The equation (7) presupposes that the effects of financial intermediation are fed into thegrowth equation indirectly through the investment equation4 as follows:

0 1 1 2 3 4 5 6 12t t t t t t t tk k BANK q OFI INTSPR M�� (8)

Using exogenous components of financial intermediary activity, the estimable equationsfor other structural models are:

0 1 1 2 3 4 5 22t t t t t t tBANK BANK GOVEXP k INTSPR M�� (9)

0 1 1 2 3 4 3t t t t t tOFI OFI q GOVEXP INTSPR�� (10)

Equations (7) to (10) are estimated simultaneously using 3SLS, this is because thesimultaneous correlations of the error terms in the models cannot be ruled out. Thus, thismethod corrects for all these defects and also estimates all the structural equations together asa set, in order to take account of both the direct and indirect effects arising from the two-wayrelationship between the rate of economic growth and the financial intermediation variables.Thisalso addresses the possibility that financial activity may be a product rather than a cause ofeconomic growth.

Four main variables are used to measure the effects of financial intermediation in theeconomy in this study,namely; private credit by deposit money banks as a percentage of GDP(BANK), insurance premium volume as a percentage of GDP (OFI), interest rate spread(INTSPR)5 measured as lending rate minus deposit rate and broad money as a percentage ofGDP (M2).These variables have been used extensively in the literature to measure the effectsof financial intermediation. Another variable seldomuse is thedeposit-to-GDP ratio which onlyshows one aspect of the development of financial intermediation, and may be the least possiblechannel through which the development of financial intermediation affects economic growth.Thus thefindings based purely on this indicator may be misleading (Webb et al., 2002).

Data for this study are sourced from WDI-Online (2011), World Bank financial StructureDatabase and Central Bank of Nigeria Statistical Bulletin (2010). Nominal values aretransformed in real values.

4. ANALYSIS OF RESULTS AND DISCUSSIONS

The time series properties of the variables are evaluated by conducting Augmented Dickey-Fuller (ADF) and Philips-Perron (PP) unit root tests. The results of the unit root are presented in


table II. The results show that all the variables are found to be non-stationary at levels, butunambiguously stationary at first difference, that is, they are integrated of order one.

Table IIUnit Root Tests

Variable Unit Root Tests ConclusionADF PP

RGDP Level -1.9983 -2.9585* I(1)

1st Difference -4.8402** -12.3902**

DCREB Level -1.7030 -1.9142 I(1)

1st Difference -5.3892** -5.3294**

INV Level -2.7854 -2.9258 I(1)

1st Difference -5.8484** -6.8040**

GOVEXP Level -4.1368* -4.1975* I(1)

1st Difference -7.0668** -13.5822**

HCD Level -0.4753 -0.4158 I(1)

1st Difference -8.0189** -9.0225**

INS Level -1.8510 -2.0070 I(1)

1st Difference -6.1538** -6.1538**

INTSP Level -1.4578 -1.1901 I(1)

1st Difference -5.4967** -4.5902**

TOT Level -1.9526 -1.9260 I(1)

1st Difference -7.4446** -7.3952**

M2 Level -1.8476 -1.3756 I(1)

1st Difference -4.4196* -4.4196*

Note: * and ** denote 1% and 5% significance level respectivelySource: Author’s Estimation

The results from the simultaneous equations using 3SLS are presented in Table III. It isobvious from the Table that all the equations in the system are over-identified. The table revealsan interesting outcome. The results from column 2, the real GDP equation identifies realinvestment, human capital development, government expenditure, initial economic growth asthe major determinants of growth in Nigeria. The results reveal a positive and significantrelationship between investment growth, human capital development and economic growth.Initial GDP growth has its expected negative sign. This result is consistent with the findingsfrom Barro and Sala-I-Martin (1995).Government expenditure and terms of trade has negativeimpact on economic growth, though the effect of TOT is not significant. This is howeversurprising, as we expect these variables to have positive impact on growth. The possibleexplanations that can be adduced is that most government expenditures are spent on unproductiveactivities (i.e. largely on recurrent expenditure) and that the country is largely import dependent.

On the investment equation, the results suggest that higher levels of financial intermediationvariables (banking and insurance) predict higher investment growth in the Nigeria. It shows a


two-way relationship between financial intermediation variables and investment. The coefficienton the banking variable suggests that a 1 percent increase in banking activity will lead to asignificant increase in investment by 0.32 on the average.Concerning the other direction of therelationship, the coefficient on the insurance indicates that a 1 percent increase in insuranceactivity will be accompanied by a significant increase of 0.35 in average investment. Initialinvestment, real GDP growth and broad money supply are all significant. However, interestrate spread has negative impact on investment though it appears insignificant in the model.This signifies that the cost of intermediation and thus the efficiency of financialintermediationhavemarginal implications for growth in Nigeria.

The last two columns model the indirect impact of financial intermediation variables(banking and insurance) on the economic growth. The results from the columns show that

Table IIIEstimated Results from Simultaneous Equations Models

Independent Variables Dependent Variables

RGDP INV BANK OFI

C -5.7906* 15.9942** -44.5710** 0.0021**(0.053) (0.000) (0.000) (0.006)

�RGDP -0.4052** -0.0000**(0.000) (0.009)

�INV 0.5347* -0.5201*(0.046) (0.011)

�BANK 0.3204**(0.000)

�OFI 0.3475*(0.011)

�GOVEXP -2.9941* 0.5022** -0.0017*(0.042) (0.000) (0.017)

�HCD 0.2875**(0.007)

�INTSP -0.1720 0.3151 -0.0000(0.420) (0.212) (0.665)

�TOT -0.0251(0.063)

�M2 0.4048** 0.9487**(0.000) (0.000)

�RGDP(-1) -0.4094**(0.000)

�INV(-1) 0.5193**(0.000)

�BANK(-1) 0.3844**(0.000)

�OFI(-1) 0.7558**(0.000)

R2 0.3570 0.9243 0.5581 0.6865N 40 40 40 40

Note: p-values are in parenthesis. ** and * denotes 1 percent and 5 percent levels of significance respectively.Source: Author’s Estimation


there exist statistically significant relationship between the lag of both financial intermediationvariables and the variables itself. Broad money supply appears positively and significant in thebanking sector equation,its coefficient implies that a 1 percent increase in the credit to theprivate sector by deposit money bank leads to 0.95 increase in broad money supply.

Another important determinant of financial intermediation variables is governmentexpenditure which appears significantly in both equations. While it has positive effects in thebanking model, its effects are negative in the insurance model. In this wise, it is interesting tonote that government expenditure is pertinent to all the equations, particularly investment andeconomic growth in Nigeria.

However, interest rate spread appears positively in the banking model, while it has negativeeffect in the insurance model. This seems that cost of intermediation is higher in the bankingsector (with coefficient of 0.32) than in the insurance sector with near zero coefficient. Thisalso point to inefficiency in the banking sector6. It however appears insignificant in both financialintermediation equations, just like in the investment equation. This finding is in congruent toReinhart and Tokatlidis (2003) who show that in poor countries where households remainclose to subsistence level of income, neither consumption nor savings are likely to be affectedby changes in interest rate.

On the whole, it appears financial intermediation variables (banking and insurance) mattersfor economic growth in Nigeria.The findings from this study clearly show that financialintermediation (measured through banking and insurance) has a positive linkage effects ongrowth, and these effects are likely to occur through investment channels. This channel is alsosupported by Harris (2012).

5. CONCLUSIONS AND POLICY RECOMMENDATIONS

The primary purpose of this study is to evaluate the effects of financial intermediation oneconomic growth in Nigeria. It also examines the detailed effects of different components offinancial intermediation on aggregate domestic investment and the economic growth. The studydevelops a small structural macro-econometric model to simultaneously assess these effectsusing the technique of 3SLS that overcome both the endogeneity and simultaneity biaswhichmay lead to misleading inferences. The findings from this study show that financial intermediationhas a positive linkage effects on growth through the investment channels. This implies thatfinancial intermediation variables (banking and insurance) matters for economic growth inNigeria. Several policy lessons can be drawn from the findings of this study. One of the obviousimplications is that policymakers should prioritise financial sector policies and devote intereston policy determinants of financial intermediation as a mechanism for promoting growth.Therefore, government that is desirous of stimulating investment and thus economic growthmust adopt appropriate mix of regulatory, fiscal and monetary policies that will enhance efficientfinancial intermediation.

Notes

1. See Schumpeter (1911), Pagano (1993), Levine, Loayza and Beck (2000), Levine (2001), Ndikumana(2003), Kasekende (2008) , Sanusi (2011) among others.


2. See Ram, (1999) and Rousseau and Wachtel, (2007) among others for extensive rationale why studies onthis interrelationship need to be country specific.

3. In this wise, financial intermediation may not be supply leading but rather demand following, whichimplies that economic growth pulls along financial activity, making financial intermediation anaccompaniment rather than a stimulant to growth.

4. This assumption is made due to data limitation, we are aware that financial intermediaries do not only givecredit to firms, they also monitor and facilitate transactions. Thus, the impact of financial intermediationon growth could be due to its effects on the level of investment as well as its influence on productivity (SeeDe Gregorio and Guidotti, 1995 for detail). However, we do not model explicitly its effects on quality ofinvestment (productivity).

5. This reflects the cost of intermediation and also measures bank intermediation efficiency.

6. High interest rate spread discourages potential savers due to low returns on deposits and thus limits lending,investment and economic growth.

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