THE IMPACT OF INFLATION ON BANKING SECTOR IN NIGERIA

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THE IMPACT OF INFLATION ON BANKING SECTOR IN NIGERIA

CHAPTER ONE

INTRODUCTION

INTRODUCTION

The financial sector is the main source of financing productive economic projects in any economy in the world. It plays a major role in the functioning of the economy through financial intermediation. Simply, the role of financial sector lies between savers and borrowers: it takes money from savers (in the form of deposits) and lends it to those who wish to borrow, such as companies, governments, or individuals. The financial sector promotes economic growth through capital accumulation and technological progress by increasing the saving rate, providing information about investment, and improving capital allocation. Numerous studies indicate that the development of financial sector plays an important role in economic development, such as (Bose & Cothren, 1996, 1997; Saint-Paul, 1992). They have introduced an endogenous growth theoretical model to clarify how the development of financial markets eases informational frictions in financial markets, enhances the economy’s efficiency of resource allocations, and thereby fosters economic growth.

The development and improvement of the financial sector also stimulates the growth of small and medium-sized enterprises (SMEs) by giving them access to finance. One of the characteristics of small and medium companies is that they are labor intensive and create more jobs than large companies, which contributes significantly to economic development in emerging economies.

BACKGROUND OF THE STUDY

The relevance of understanding the macroeconomic determinants of financial development lies in the fact that a more active financial sector is of great importance for economic growth and income inequality, which are of high priority in macroeconomic objectives of any developing countrys, like Nigeria. Both theoretical and empirical evidences reveal that developed financial sector mobilizes savings efficiently and reallocates the resources to productive activities and subsequently stimulates economic activities in the country. For instance, while the studies of King and Levine (1993), Levine and Zervos (1998), Beck, et al. (2000), and Beck and Levine (2004) report that financial development has a positive impact on long-run growth, Li, et al. (1998), Dollar and Kraay (2002), Clark, et al. (2003), Odiambho (2004) , Bonfiglioli (2005), Bittencourt (2007a) and Beck, et al. (2007) on the other hand established that financial development reduces income inequality.

However, high rate of inflation worsens the efficiency of financial sector through financial market frictions and slows down the economic performance. Therefore, high inflation rate has become not only a concern in the industrial and emerging market economies but to the general economy of nations, hence price stability becomes the focus of monetary authorities upon overwhelming empirical evidence that it is only in the midst of price stability that sustainable growth can be achieved. Inflationary conditions imply that general price level keeps increasing over time. Low and stable inflation rates allow the private sector to plan for the future, lead to a lower need for costly price adjustments, prevent tax distortion and thus create a stable business environment (Bencivenga and Smith, 1993). Thus, the policy makers are so obsessed about inflation because of its implication on the economy such as; it discourages long term planning, reduces savings and capital accumulation, reduces investment, brings about shift in the distribution of real income and consequent misallocation of resources and creates uncertainty and distortions in the information content of prices.

STATEMENT OF THE PROBLEM

The problem of inflation in Nigeria has been confronted in variety of ways by the government of the country using different macro-economic policies. The government introduced several measures e.g. National Development Structural adjustment Programmes (SAPs). Guided Deregulation etc. to combat this problem. Despite all these measures, we still experience inflation in the country.

The question now is, why we still experience inflationary conditions after all these variety of measures adopted by the government to control it or reduce it intensity?

Moreover, the issue of monetary policy has its objectives one of which is tackling the problem of inflation. The Central Bank applied all measures to control it still every effort seem to be fruitless.

The nest question is why have all these measures failed in combating the problem of inflation?

OBJJECTIVES OF THE STUDY

To highlight the relevance of monetary policy in combating inflation.

Try to explain the various types of monetary policy that can be used to combat inflation and other macro-economic problems.

Identify and discuss the monetary policy problems with particular reference to Nigeria.

To explain the various instruments of monetary policy that can be used to combat inflation especially in less developed Countries (LDCS) such as Nigeria.

RESEARCH HYPOTHESIS

Ho₁: Monetary Policy is not an effective tool of macro-economic stabilization of an economy.

Hi₁: Monetary Policy is a very effective tool of macro-economic stabilization of an economy.

Ho₂: Money supply has no impact on the Level of economic activities and growth.

Hi₂: Money supply has an impact on the level of economic activities and rate of growth.

Ho₃: Central Bank of Nigeria’s monetary and credit Policy guidelines and money supply do not have impact on the level of outputs.

Hi₃: Central Bank of Nigeria’s monetary and credit Policy guidelines and money supply do have impact on the level of outputs.

SIGNIFICANCE OF THE STUDY

However, this research work will assist the economy to derive possible solution to the research problem e.g. control of inflation using monetary policy measures as adopted by the monetary authorities of the Central Bank.

Furthermore, the research ex-rays the various types of monetary policy measures, which can be used to combat the problem of unstable economy and prices, and as a result will be a kind of research materials to those in various fields may be of immense use of future researchers.

Government will benefit immensely from this research works as the topic is very relevant in the field of macro-economic policy formulation.

SCOPE AND LIMITATIONS OF THE STUDY

However, study of this nature is known to be subject to a number of problems or constrains, which are peculiar to the Nigerian society such as financial constraints. This research work was not an exception the problem of visiting the Central Bank of Nigerian and some other places for data collection involved spending a lot of money or transport expenses.

Hence, the predicament of the overage students can therefore be imagined.

Furthermore, the issue of office protocols time limit, secrecy inadequate research materials also were some setbacks to the researchers in carrying out this research.

1.7 ORGANIZATIONAL STRUCTURE OF THE STUDY

A Central Bank is a financial institution owned by the government of a nations run by Board of Directors, Chaired by Governor appointed by the government and charged with the responsibility of managing the expansion and contraction of the volume, cost and availability of money in the interest of public welfare. It is primarily a non- profit entity in U.S. it is called the Federal Leisure while in the U.K. it is the bank of England.

1.8 DEFINITION OF TERMS

Expansionary Monetary Policy: Is a monetary policy that seeks to increase the size and volume of money supply, it can be increase by buy bonds in exchange for hard currency payment to adds that amount of currency to the money supply.
Contractionary Monetary Policy: This is the policy that can be implemented by reducing the size and volume of monetary base by the way of sell bonds in exchange for hard currency, by so doing it removes that amount of currency from the economy.
Reserve Requirement: Commercial banks are required to maintain certain reserve requirement in order to control their liquidity and influence their credit operations, these are usually expressed as a percentage of customers deposits.
Discount Rate: The discount rate is the rate of interest the monetary authorities charge the commercial banks on loans extended to them. If the Central Bank wishes to increased liquidity and investment, it reduces the discount rate, and on the other hand if the Central Bank wishes to reduce liquidity in economy, it raises the discount rate.
Liquidity Ration: The Central Bank imposes upon the bank a minimum liquidity ratio, being vary to the needs of the situation. It is designed to enhance the ability of bank to meet cash withdrawals in them by their customers. Such liquidity ratio stands for the proportion of specified assets.
Open Market Operation (OMO): This involves the Central Bank Discretionary power to sell or purchase securities in the financial market in order to influence the volume of credit and interest rate which consequently affect money supply. The securities include treasury certificates, treasury bill and development stock
Moral Suasion: Is the act of public pronouncements or outright appeal on the apart of monetary authorities to the banks requesting them to operate in a particular direction for the realization of specified government objectives.
Economic Growth: This is a process whereby the real per-capital income of a country increases over a long period of time. Economic growth is measured by the increase in the amount of goods services produced deposits are savings and currents account of deposits in a commercial bank.
Money Supply: Is a currency with the public and demand deposits with commercial banks. Demand deposits are savings and current account of depositors in a commercial bank.
Economic Life Cycle: This refers to a view of product design, each stages of the product’s life is assessed in terms of cost, at each stage of this life cycle choice have to be made.