Financial Development–Growth Nexus in Nigeria: Empirical Investigation based on Vector AutoRegressive (VAR) Approach

Abstract

The paper reexamines the nexus between financial sector development and economic growth in Nigeria over the period 1970-2011. Prior to the study, most of the earlier works use financial deepening to proxy financial development and conclude that financial development do not cause growth. The paper seeks to investigate the hypothesis that financial development is positively related to growth. Using four measures-ratios of broad money (MSY), bank deposit liabilities (BDY), domestic credit (DCY), private sector credit (PSY)-to proxy financial development, and adopting Granger causality tests in a VAR framework, the empirical result suggests that financial sector development is positively related to and therefore causes economic growth just as finance is growth dependent-a case of bi-directional causality. The variance decomposition shows that the variations in DCY and PSY are significantly and dominantly affected by MSY. This suggests, among others, that expansion of savings by DMBs through saver-oriented real deposit rate (RDR) translate to domestic credit with higher proportion utilized by the private sector. Among other measures, the establishment of a functional Asset Management Corporation should be hastened to free DMBs from non-performing loans and enhance their ability to expand private sector credits. Equally, to sustain the influence of finance on growth and vice versa, the current reforms in the financial sector should be sustained while focusing on complementary and coordinated institutional and structural reforms in the real sector to ensure simultaneity in the development of the financial and real sectors of the economy.