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Impact of Deposit Money Banks’ Lending Rate and Its Economic Growth in Nigeria: An Empirical Investigation (1986 – 2022)

This article is published by the Zamfara International Journal of Humanities.

By

N.D. Ahmadu
1Department of Humanity and Social Sciences,
Federal Polytechnic, Nasarawa,
Nasarawa -Nigeria.
donnoelah@gmail.com1, 

I. D Nkon1 & M. B. Gozuk2,
1,2Department of Economics,
University of Jos,
Plateau - Nigeria.
nkonishaku@gmail.com1, magdalenegozuk@gmail.com32 

Abstract

The impact of Deposit Money Banks’ (DMB) lending rate on Economic Growth in Nigeria was examined in this study. Time series secondary data on deposit money banks’ lending rate, Gross Domestic Product, and loans and advances spanning between the period 1986-2022 were collated from the Central Bank of Nigeria’s (CBN) Statistical Bulletin and used to run a regression using the Auto-regressive Lag Technique. The other instrumentality adopted in the study included among others; Augmented Dickey-Fuller, Error Correction Mechanism, and Cusum of Squares. The coefficient of Deposit Money Banks’ lending rate (-2.6132) shows that a negative and insignificant relationship at a 5% level of significance exists between Deposit Money Banks’ lending rate and Gross Domestic Product (GDP). The coefficient of total loans and advances (-0.1614) shows that a negative and insignificant relationship at a 5% level of significance exists between Economic Growth and the lending rate in Nigeria. It was discovered that Deposit Money Banks’ lending standards which discriminate between firms based on the credit risk of the various sectors of the economy thereby leading to the under-performance of Deposit Money Banks’ loans and advances. The study recommends among other things that; Government should implement appropriate policies that will change Banks’ lending behaviour that discriminates between firms based on the credit risk and encourage lending standards that will ensure that funds get to the production sector rather than unproductive ventures and individual pockets.

 Key words: Economic Growth, Gross Domestic Product, Error Correction, Mechanism, Deposit Money Banks, Lending Rate


Introduction

The economic growth of any country reflects its capacity to increase the production of goods and services which to a large extent depends on the interest rate. It has been asserted by Etale and Ayunka, (2016) that high-interest rates discourage investment and thereby forestall economic growth. Similarly, a high-interest rate increases the cost of borrowing which could ultimately lead to the reduction of output; hence spurring up the unemployment rate in a country such as Nigeria, while a low-interest rate is likely to stimulate production and real economic development. However, before the deregulation of the banking sector in Nigeria in 1986, interest rates were administratively determined by the Central Bank of Nigeria (CBN) and there were ceilings on both Deposits and Lending rates.

During this period, most developing countries intervened substantially in their financial sector just like Nigeria, by setting interest rates and equally directing the allocation of credit to accelerate the most desired development in the economy. This development was said to be counter-productive as the repressed financial sector could not mobilize loanable funds for investment. Thus, this led to the financial sector reforms to correct the financial repression problem caused therefrom. This consequently, led to the introduction of reforms such as the removal of the ceiling and other controls on credit allocation and the interest rate liberation. The financial reforms which commenced in July 1986 relied mainly on market forces and the main objective was to eliminate the financial repression to improve the incentive structure and ensure productive efficiency in the economy (Obainuyi and Olorunfemi, 2011). 

The review of the past empirical literature on this field showed a lack of consensus among the findings of scholars, indicating the existence of a research gap. This study attempts to bridge that gap and contribute to existing literature. Thus, the main objective of this study is to examine the relationship between interest rate and Economic Growth in Nigeria. Deposit Money Banks’ loans were introduced as the control variable for a more robust analysis of data and testing of hypotheses.

 

Literature Review and Conceptual Clarification

Concept of Deposit Money Banks’ Lending Rate

Deposit Money Banks’ lending rate is the reward DMB receives for issuing loans to the public. It is the cost of borrowing from DMBs usually expressed as a percentage of the amount borrowed. Adebiyi (2002) stated that Deposit Money Banks' lending rate is the return or yield on Equity or the Opportunity Cost of the current consumption been deferring into the future.

Jhingan (2003) citing Professor Lerner asserts that Deposit Money Banks’ lending rate is the price that equates the Demand for credit or Investment plus Net 'Hoarding' to the supply of Credit or Savings plus the Net increase in the amount of money in the period. In this definition, the lending rate is considered the price of credit which, unlike other prices, is determined solely by the forces of demand and supply of loanable funds.

Piana (2002) postulates that the lending rate is the difference (in percentage) between money paid back and money collected earlier from Deposit Money Banks, keeping into account the amount of time that elapsed. Similarly, Kumar (2018) describes the lending rate as the price paid by the borrower of money to its lender (Deposit Money Bank).

The definition given by Piana (2002) earlier is adopted as the operational concept for this study. It is adopted because this study sees Deposit Money Banks’ lending rate as the difference (in percentage) between money paid back and money collected earlier from Deposit Money Banks, keeping into account the amount of time that elapsed.

 

Economic Growth: Conceptualization

Economic growth can be seen as an increase in economic variables (National Income, Savings, Investment, and Output of a country). Haller (2012) asserted that economic growth is the process of increasing the sizes of national economies that is, the macro-economic indicators especially the GDP per capita, in an ascendant but not necessarily linear direction, with positive effects on the economic-social sector. Zhattau, Abdullahi, and Pam (2016) citing Lipsey and Chrystal saw economic growth as the long-term increase in the standard of living of people. So, economic growth is seen as a powerful tool for improving the livelihood of the people. Economic growth according to Obadan and Okojie (2010) is an increase in the average rate of production of a country usually measured within one year. Todaro and Smith (2006) posited that economic growth is a steady process by which the productive capacity of the economy is increased over time to bring about rising levels of national output and income.

Economic growth is an important aspect of economic performance which is determined by two major factors. That is an increase in the efficiency of labour as a result of advances in technology and improvements in economic and social organization. Kuznets (1971) believes that economic growth is a persistent rise in the supply of diverse Economic goods to a country’s population as a result of advancements in Technology, Institutional and Ideological adjustments needed. He explained further that, technological advancement will definitely lead to economic growth provided positive institutions, attitudinal and ideological changes are made. Nwosu (2000) also is of the view that economic growth is the process of augmenting the productive forces or expanding productive capacity which is accomplished by effective mobilization, assemblage, and management of human, mental and financial resources.   

The definition given by Haller (2012) is adopted as the operational concept for this study; because this study sees economic growth as the increase in Gross Domestic Product (GDP) as a result of the efficient mobilization of funds from surplus spenders to deficit spenders in the economy at a given cost.

 

Empirical Review

Obamuyi (2009) examined the relationship between interest rate liberalization and economic growth in Nigeria. Using time series analysis and annual data from 1970 to 2006, he applied a co-integration and error correction model to capture both the long-run and short-run dynamics of the variables in the model. The result showed that the real lending rates have significant effects on economic growth and a long-run relationship exists between economic growth and interest rate liberalization. He concluded that the behaviour of interest rate in a liberalized economy is important for Economic Growth. 

Moreso, Owusu (2011), in his empirical findings shows that in the long run interest rate liberalization will lead to economic growth in Nigeria. Also, the studies of Chipote, Mgxekwa, and Godza (2014), who examined financial liberalization on economic growth in South Africa, employed the VECM technique and found long-run equilibrium conditions among the variables included in the model, lending rate and financial deepening have a positive influence on economic growth as the exchange rate negatively impacted on it.

Ogun (1986) using a cross-sectional analysis of data for 20 countries in Africa from 1969 – 1983 estimated the correlation between interest rate liberalization and economic growth and finds no support for the economic growth enhancing capabilities of financial liberalization. Owusu and Odhiambo (2013) investigated financial liberalization and economic growth in the Ivory Coast with the use of the Auto-regressive Distributed Lag (ARDL) framework. Their findings show that the effect of financial liberalization policies on Economic Growth is negligible; both in the short-run and long-run situations.  

Also, Obainuyi and Olorunfemi (2011) examined the implications of the financial reforms and interest rate behaviour on the economic growth in Nigeria. The study involved statistical time series panel data collected for the period 1970 – 2016. They employed co-integration statistics and an error correction model to analyze their study data. The results of the study indicated that financial reforms and interest rates have a sufficient impact on economic growth in Nigeria. They concluded that interest rate behaviour has important economic implications for economic growth and development in Nigeria. 

In a related study, Udoka and Roland (2012) investigated the effect of Interest rate fluctuation on the economic growth of Nigeria for the period 1970 – 2010, using the ordinary least square multiple regression analytical technique. Their analysis spanned two time periods; before and after the interest rate deregulation regimes. Their ex-post facto research design used secondary time series panel data collected from the Central Bank of Nigeria (CBN) statistical Bulletin. The findings revealed that interest rate had an inverse relationship with economic growth in Nigeria.

Nwanyanwu (2010) examined the role of banks’ credit on the Nigerian economic growth from 1992-2008 and found out that bank credit has not impacted significantly on the growth of the Nigerian economy. She used simple regression analysis with GDP as a function of domestic bank credit.

Akujuobi and Chima (2012) examined the effect of commercial bank credit on the production sector and economic development in Nigeria. Adopting the multiple regression model for data spanning the period 1960-2008. The study concluded that Commercial banks’ lending to the production sector has not performed well in terms of contribution to Nigeria’s economic development which could be due to the deviation of credits to other non-productive sectors.

Makali (2014) examined the effect of commercial bank loans on the Economic Growth of Kenya. The data from 2008 to 2012 that covered all the forty-three banks in Kenya showed that the economic growth rate was not normally distributed but skewed towards the right, the distribution of the rate of change of loans issued to borrowers was normally distributed, and the correlations between Economic Growth rate and the rate of change in the amounts of loans issued was -0.097 as measured by the Pearson’s Correlation coefficient. This indicates that a positive change in amounts of loans issued was matched with a slight drop in Economic Growth. He concluded that economic growth in Kenya is not strongly determined by loans issued by banks to private borrowers. 

Mamman and Hashim (2014) examined the impact of bank lending on Economic Growth in Nigeria for the period 1989-2012. The study relied on secondary data; using multiple regression analysis, the study found out that bank lending accounts for about 82.6% variation in Economic Growth in Nigeria for the period under study. The study concludes that there is a statistically significant impact of bank lending on economic growth in Nigeria which shows that the performance of the Nigerian economy is greatly influenced by bank lending.

 

Theoretical Framework:Schumpeterian Theory

The basis for adopting this theory is that its explanation incorporates the need for lending rate on Banks’ Credit and its impact on Economic Growth which is the basis of this research. Schumpeter in the theory assumes a perfectly competitive economy that is in stationary equilibrium. In such a stationary state, there is perfect competitive equilibrium without profits, interest rates, savings, investment, and involuntary unemployment. According to Schumpeter, this equilibrium is characterized by circular flow which continues to repeat itself in the same manner year after year. In the circular flow, the same products are produced every year in the same manner, “for every demand, there awaits somewhere in the economic system a corresponding supply.”

Schumpeter noted that development is a spontaneous and discontinued change in the channels of the circular flow, disturbance of equilibrium, which forever alters and displaces the equilibrium state previously existing. These spontaneous and discontinuous changes in economic life are not forced from without but arise by their initiative from within the economy and appear in the sphere of industrial and commercial life. The development consists of the carrying out of new combinations for which possibilities exist in the stationary state. New combinations come about in the form of innovations which he assigned the role to the entrepreneur who innovates to earn profits.

The entrepreneur breaks up the circular flow with innovation to earn profits. The circular flow is broken by bank credit expansion. Since investment in innovation is risky the entrepreneur must pay interest on it. Once the innovation becomes successful and profitable, other entrepreneurs follow it in “swarm-like clusters.” Innovation in one field may induce other innovations in related fields. For instance, the emergence of the car industry will bring about investments in the construction of highways, rubber tyres, and petroleum products (Jhingan, 2013).

 

 

Methodology

Sources of Data

The data for the study are mainly time series secondary data sourced from the Central Bank of Nigeria Statistical Bulletin for the period 1986 to 2022. The choice of the period 1986 to 2020 is to cover various banking reforms embarked upon by the regulatory authority.

The variables under study include the Gross Domestic Product (GDP) which is used as a proxy for economic growth and is the dependent variable. It is gotten by summing the values of the domestic products of the various sectors of the economy. The lending rate is the first explanatory variable. It is the main explanatory variable in the study whose effect on economic growth the study intends to examine. The next variable is Deposit Money Banks’ credit to various sectors of the economy. It is used as a control variable.


Model Specification

The model for this research study is specified in the following functional form:

GDPt  = f(LDtt,LRt)

The stochastic relationship is shown below:

GDPt  = β0 + β1LRt + β2LDt+ εt

Where:

GDPt   = the Gross Domestic Product of Nigeria which measure economic growth.  

LDt    = Deposit money banks’ loans and advances to various sectors of   the Economy.

LRt         = Lending rate

t              = the time period chosen for this study from 1986-2022.

β0                  = the constant term for model

β1, β2,  = slopes of the independent variables

εt                   = the error term which captures other variables that affect the changes in  the dependent variable but are not mentioned in the model.

 


Apriori Expectation

 

Theoretically, it is expected that Deposit Money Banks’ lending rate will harm Economic Growth (GDP) while the lending will have a positive impact on economic growth.

 

Method of Data Analysis

The study adopted the multiple regression techniques of Ordinary Least Square to establish the macroeconomic relationship between the lending rate and economic growth in Nigeria. Analytic tests such as unit root, auto-correlation, and normality tests were also conducted.

 

Presentation and Discussion of Results

This section contains the results and the discussion of the results obtained from the analysis of data. Data for all the variables were converted into natural logarithms since they are not of an equal unit of measurement. The justification is to ensure that the data do not give biased result. 


 

Table 1: Augmented Dickey Fuller Result of Unit Root Test - Summary of the Augmented Dicky-fuller Result

                                                                                                                                                                               

Variable                 ADF Stats.              P. Value                  5% Critical             Order of

 Integration           Remarks

Ln (GDP)t               -6.2121                  0.0000                   -2.9604                  1(1)                         Stationary

                                                                                                                                                                               

Ln (LD)t                            -5.8695                  0.0000                   -2.9604                  1(1)                         Stationary

 

Ln (LR)t                            -4.3135                  0.0019                   -2.9571                  1(0)                         Stationary

 

Source: Author’s computation using E-view 9.0, 2022

 


The result in table 1 shows that Gross Domestic Product Growth and Total Deposit Bank’s lending was stationary at first differencing while Deposit Bank’s lending rate was stationary at level.


 

 

 

 

 

Model Estimation

Table 2: ARDL Co-integrating and Long-Run Form

Vector Auto-regression Estimates

                                 GDP

            GDP (-1)                0.735911

                                            (0.19603)

                                            [ 3.75414]

                                                           

            GDP (-2)                0.002148

                                            (0.20237)

                                            [ 0.01062]

                                                           

            C                             1.713730

                                            (4.18098)

                                            [ 0.40989]

                                                           

            LR                          0.470905

                                            (1.39294)

                                            [ 0.33806]

                                                           

            LD                          -0.049764

                                            (0.10336)

                                            [-0.48145]

                                           

R-Square                           0.583573

Adj R-Square                   0.519507

Sum Sq resids                   42.14903

S.             E. Equation                          1.273231

F-Stats                                               9.108981

Log likelihood                  -48.74908

Alkalike AlC                     3.467682

Schwarz SC                      3.698971

Mean depandent                             10.73662

 

Source: Author’s computation using E-view 9.0, 2022

 

Table 3: Long-Run Coefficients

The Long-run dynamics of the estimated parameter is depicted below;

Variable          Coefficient      Std. Error        t-Stats.             Prob.

LD                    -0.1614            0.1296             -1.2451            0.2227

LR                    -2.6132            1.5105             1.7301             0.0939

C                      3.5606             4.5992             0.7742             0.4449

Source: Author’s computation using E-view 9.0, 2022

 

 


The result in Table 2 shows the vector auto-regressive result. It is a model used to restore equilibrium and validate the long-run equilibrium relationship existing among the variables. The result shows the long-run and short-run relationship between Deposit Money Banks’ lending rates and Economic Growth in Nigeria. 

The coefficient of lending rate (LR) (β1= 0.4709) shows that a relationship exists between economic growth and the lending rate in Nigeria. The result shows that if all the independent variables are kept constant, there will be an increase in economic growth by 0.4709 units as a result of a unit increase in interest rate in the short run. 

Based on the E-views 9 output shown in table 2, the result of the regression analysis for the model is interpreted as follows: The coefficient of Deposit Money Banks’ loans and advances (LD) (β1= -0.049) shows that a negative relationship exists between Deposit Money Banks’ lending and Gross Domestic Product (GDP). It shows that GDP falls by 0.049 units as a result of a unit increase in Deposit Money Banks’ lending in Nigeria in the short run, keeping all the other independent variables constant.

 

Long-run

For this study, the long-run effect of Deposit Money Banks’ lending rate on economic growth in Nigeria is our focus. From the result, in table 3 the long-run effect of the Deposit Money Bank lending rate (LR) has a negative sign. This sign indicates that lending rates have a decreasing effect on economic growth. The probability value shows that the statistic is insignificant at a 5% level of significance. 

The long-run effect of Deposit Money Bank lending (loans and advances) (LD) has a negative sign. This sign indicates that loans and advances have a decreasing effect on economic growth. The probability value shows that the statistic is insignificant at a 5% level of significance. This implies that most Deposit Money Banks’ loans and advances collected are not used for feasible investment purposes expected to bring about economic growth in Nigeria. 

 

Discussion of Finding

The result of the relationship between Deposit Money Banks’ lending rate and GDP indicated that there is no significant relationship between Deposit Money Banks’ lending rate and Economic Growth in Nigeria. This result supports the work of Owusu and Odhiambo (2013) whose findings show that the effect of financial liberalization policies on Economic Growth is negligible; both in the short-run and long-run situations and Udoka and Roland (2012) whose findings revealed that interest rate had an inverse relationship with economic growth in Nigeria.

On the contrary, the finding does not support the result of Obamuyi (2009) who examined the relationship between interest rates liberalization and economic growth in Nigeria and concluded that real lending rates have significant effects on economic growth. It also contradicts the result of Obainuyi and Olorunfemi (2011) who examined the implications of the financial reforms and interest rate behaviour on the economic growth in Nigeria and concluded that financial reforms and interest rates have a sufficient impact on economic growth in Nigeria.

 

Conclusion and Recommendations

The banking sector in Nigeria has witnessed significant growth since the adoption of the structural adjustment program (SAP) with the potential to contribute to the growth of the Nigerian Economy. Thus, the impact of Deposit Money Banks’ lending rates on economic growth in Nigeria has been discussed in this study. 

Based on the result of this research study, the following policy recommendations were made:

        I.            Government should implement appropriate policies that will change banks’ lending behaviour that discriminates between firms based on the credit risk and encourage lending standards that will ensure that funds go to the production sector rather than individual pockets and unproductive ventures;

       II.            There should be a strong and comprehensive legal framework that will aid in monitoring the performance of commercial banks’ loans and advances to the private sector and recovering debts owed to the banks;

     III.            The issue of high-interest rates should also be resolved since businesses are likely to migrate to a less risky environment where the cost of capital is low leading to low domestic production capabilities of the Nigerian private sector.


 

References

 

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Akujuobi, A. B. C., &Chima, C. C. (2012). The Production Sector Credit and Economic Development of Nigeria, Co-integration Analysis. In International Journal of Economics and Management research, 2(2) pp. 1.

Etale, L. M. and Ayunku, P. E. (2016). The Relationship between Interest Rate       and Economic Growth in Nigeria: An Error Correction Model (ECM) Approach. In International Journal of Economics and Financial Research,  2 (6), pp. 127-131.

 

Haller, A. (2012). “Concepts of Economic Growth and Development. Challenges of Crisis and of Knowledge”. Knowledge based society project financed from the European social find and by the Romanian government. Retrieved June 10, 2019 from          www.ugb.ro/etc/etc2012no1/09fa.pdf

 

Jhingan, M. L. (2003).  Macroeconomic Theory. Delhi: Vrinda Publication (P)                          Ltd

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Makali, J. M. (2014). The Effect of Commercial Bank Loans on the Economic Growth of Kenya. Unpublished  research Project proposal, University of Nairobi, Nairobi. Retrieved June 14, 2019 from:                 http://chss.uonbi.ac.ke/sites/default/files/chss/MAKALI%20JASON%20MULU.pdf

 

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