Impact of Banking Credit on Economic Growth: Nigeria Case Study

This research report investigates the relationship between banking credit and economic growth in Nigeria. It explores the significant role of the banking sector in financing economic projects and activities, emphasizing the importance of credit development for sustainable growth. The report examines the impact of banking credit on commercial activities, trade, and capital accumulation, supported by literature reviews on credit creation and maturity transformation. The study analyzes the evolution of the banking sector in Nigeria, including the effects of reforms, and its influence on economic indicators such as GDP and lending rates. It also discusses the relationship between bank credit and economic growth, highlighting the positive impact of improved financial policies and practices. The report concludes with an analysis of the implications for Nigeria's economic development.

Banking Credit and Economic Growth in Nigeria
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TABLE OF CONTENTS
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CHAPTER ONE: INTRODUCTION
Introduction
1.1 Overview of Research
Banking sector plays an essential role within the growth as well as the development of the
economy. The reason behind this is that banks provide a medium where individuals can keep
their money secure, which is further lent by them to other people, businesses and manufacturers.
This helps in enhancing the quality of commercial affairs, infrastructure and development of a
society that also contribute toward the economic condition of the country. This research report
will analyse the banking credit and its relation to the economy. The main reason for conducting
this research is to determine the impact of banking credit on the economic condition of Nigeria.
This is because banks within a developing country play a significant role in financing their
economic projects as well as activities which support in providing sustainable economic growth.
The financial and credit development of a country plays a crucial role in the economic growth of
the country by improving the efficiency of loan, raising saving and promoting capital
accumulation (Komal and Abbas, 2015).
1.2 Aim of the study
The main aim behind conducting this study is to determine the impact that banking credit have
over the economic growth of Nigeria.
1.3 Background of research
This research investigates the “Banking credit and economic development in Nigeria”, which
focuses on studying banking activities as well as its condition, which directly affects the
economic growth of the country (Tongurai and Vithessonthi, 2018). This is because the banking
sector plays a crucial role in the financial status of the country by creating money and facilitating
internal as well as international trade. Banking credit is considered a significant factor on
commercial activities as the majority of trade is done over credit and to conduct this banks issue
guarantee on behalf of its client so that business can get sound on credit which further paid by
the bank (Castro, V., 2013).
The experience of Nigeria is getting the most significant advantage in its economic development
and social progress through the capital generated by the banking industry. The central bank of
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Nigeria stated that to make the economy function efficiently structural rigidity and access to
credit is essential for financial development (Babajide, Adegboye and Omankhanlen, 2015).
Banking sector contributes to economic growth by attracting and gathering deposits from savers.
In addition to this, it also plays a crucial role in providing loans for encouraging investment as
well as productions. Apart from that banking credit also help in creating economic expansion
within several sectors such as agricultural sectors, infrastructure, trade transactions and
contribute toward initial capital related with investment projects (Taiwo, Falohun and Agwu,
2016).
1.7 Structure of the Dissertation
Chapter 1: Introduction
The research work starts with an introduction about the topic of the investigation along with aims
as well as objective behind conducting this report.
Chapter 2: Literature review
This would be the second chapter of research that includes a critical evaluation of the previous
literature. Literature review is conducted in this research to develop a theoretical framework and
an understanding regarding the past study as well as current information.
Chapter 3: Research Methodology
In this section, different tools and techniques will be used that help in collecting and analysing
the information gathered to provide valid results.
Chapter 4: Data Analysis
This part of research relates to the accumulation of data which would be further analysed and
interpreted for shedding light over research objectives and questions once the data collection is
concluded. This is considered as one of the essential parts of research in which data gathered
would be analysed and interpreted for shedding light over research objectives and questions.
Chapter 5: Conclusion and Recommendations
This section includes the summary of the findings of whole research that help in determining the
validity and reliability of research.
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CHAPTER TWO: LITERATURE REVIEW
Banking Sector and Credit Creation
Oluitan (2012) observes that Bank credit expands to loans and advances. It refers to the
expansion of deposits and increment of credit. Banks maintain a part of their deposits as the
minimum reserve so that they can keep up with the requirements of investors/depositors and will
also be able to earn interest by lending the remaining amount. Nigeria's Bank Credit to the
Private Sector is approximately 22.29% of GDP in 2009, as observed by the experts of Global
Economy (2019). Every time a bank gives a loan to someone, it creates an equal deposit to
balance it. Thus, credit creation expands the functions of banks. According to Mohammed
Julfekar Haider (2010), Credit Creation process starts when a customer makes a deposit in a
bank, as the customer will not immediately withdraw the amount, banks put it as a reserve and
give the loans in exchange of interest, to keep the process going, banks need to have minimum
deposits policy. Credit Creation is crucial because it provides loans and advances to all the
sectors for their development and growth. World Bank Group (2017), the domestic credit to
private sector worldwide was 104.714%. Out of this, Nigeria held 23.334% of the total domestic
credit.
According to Michele Saba (2010), the representation of banks as subsidiaries is perceived by
the credit creation philosophies. A single bank cannot create credit. It is a dependent factor that
affects the economy. Credit Creation is viewed as one the major and the essential function in the
Banking Sector. The element through which a bank generates the most profit is by credit creation
as for this, they are willing to accept cash in the form of deposits and are willing to provide
loans. Okafor (2013) states that credit creation was increasingly used in the Nigerian Banking
System from 2005. Marshal and Onyekachi (2014) found that the banking sector of Nigeria
closely mirrored the changes occurring in the oil prices as well as the presence of volatility in the
market. This led to an increase in the number of deposits made in the banks, the effect of which
reflected as an increase in the credit. The main reason behind the growth of credit in this sector
can be attributed to the abundant availability of capital, mainly accelerated due to the rise in
depositories, led to credit creation which quadrupled between 2004 and 2009. As a result, the
banking assets also experienced a 76% rise between 2004 and 2009 in Nigeria. Onoh and
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Iheanacho (2017) observe that Nigeria's current Banking Sector is a result of the recent global
financial and economic crisis as well as its exposure to oil, gas and non-performing loans. Based
on these factors, the Banking Sector underwent four phases spanning between a time period of
1993 and 2009.
Maturity Transformation
Banks are also involved in the Maturity Transformation. According to Moorad Choudhry (2013),
Maturity Transformation is a vital function to continue economic growth. The process of
Maturity Transformation includes meeting the needs of lenders and borrowers by converting
short term deposits or savings and money market loans into long term borrowings such as
Mortgages. The industry is working for the high capital investments, and it is only possible
because of the role performed by the banks and financial intermediation for the establishment
and the function of Maturity Transformation (Ductor and Grechyna, 2015). They collect money
from the depositors and then lend it to the borrowers in exchange of interest. Hence, banks
collect the short-term deposits and transform them into the long-term loan and collect the
difference as profits.
The development of Banking Sector in Nigeria and its influence over economic growth
According to Eugene (2016), the role of banking in the economic development of a country
cannot be overemphasised. This is because money is considered as lifeblood, which helps in
achieving sustainability in the modern era. To achieve sustainability in the banking sector,
Central Bank of Nigeria focuses on raising the shareholder's fund, i.e. 2 billion to 25 billion for a
commercial bank with the help of the recapitalisation process. Eugene (2016) in his article
examining the impact of the banking sector on the economic growth in Nigeria states that this
leads to a merger and acquisition of several banks and as a result of which several weak banks
get closed. This also results in the emergence of 25 standards of commercial bank in the country,
which help in making Nigeria bank more stable, competent, reliable and competitive globally.
This helps Nigeria to improve its relationship with other countries globally and as a result of
which it would be able to motivate businesses to perform their trade transactions within the
country. This helps the country to increase trade transaction between businesses and as a result of
which bank credit activities have been enhanced where banks of Nigeria provide guarantee on
behalf of the client. As per the report published by Oxford Business Group (2017) on Nigeria, it
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has been analysed by the IMF that 45% of loans that are held by the bank are in foreign currency.
Hence at the time of devaluation book value of this loan get increased instantly.
According to Alkali Ibrahim Abubakar (2013), instead of several banking sector reform
implementations, the real sector of the country has faced several difficulties in assessing the
financial resources especially in commercial banks which hold up around 90% of total assets of
the financial sector. Nigeria majorly faced these issues between the years 1970-2010, but after
reforms, the banking sector encouraged trade openness and liquid liability of commercial banks,
which exerted a positive influence over the economic growth of the country. This has been
done by providing credit to the private sector, government borrowing and higher interest rate.
These all supported Nigeria to enjoy healthy revenue as well as asset growth. From the study
performed and published by Central bank of Nigeria (CBN) in its Economic Update (2019) it has
been identified that financial sector of the country excluding insurance services contributed up to
2.6% in GDP of the country in 2016 over 2010. In addition to this, Abubakar (2013) in his article
published investigating the banking sector development and its impact on the economic growth
states that the average prime lending rate of commercial bank slightly increased up-to 17.1%
from 16.9% at the end of 2016. However, Ductor and Grechyna (2014) assert in their findings
that the effect of financial development on growth proves to be adverse when the increase in
credit is not accompanied by a similar increase in the generation of real output.
Relationship between bank credit and economic growth of Nigeria
As per Akinlo and Oni (2015), the financial sectors have a positive influence on the growth and
success of countries' economies. Therefore, the banking sector of Nigeria can have a significant
influence on the economic growth of the country. This had been performed after improving the
financial policies as well as practices, which was done by financial regularities by improving the
reform and standards implemented by banks. Eugene (2016) also asserts that this includes a rise
in minimum shareholder's fund for the commercial bank from 2 billion to 25 billion which leads
to the inability of banks which operates at a lower level to raise their required capital. As a result
of which weak bank segment are getting merged or acquired by other banks in Nigeria that
further contributed to improving the financial practices of the country.
These practices supported the country to improve its financial effectiveness and ability of banks
to provide trade credit or guarantees on behalf of clients from providing or taking bank credit to
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perform international trade transactions. This has contributed toward improving the relation of
Nigeria with other countries and increasing the bank credit transactions. These all contribute
toward the economic growth of the country by holding around 45% of the loan in the form of
foreign currency. This further contributed to increasing the capital held by the bank of Nigeria
that further supported the economic growth of the country.
According to the viewpoint of Olowofeso, Adeleke and Udoji (2015), banking practices of
Nigeria are the reason behind the economic as well as social progress of country after the
reformation of public policies by Financial regulators. The Nigerian banking system is currently
having around 942 micro-finance banks, 64 financial companies, 6 development financial banks
and 5 discount houses. Abubakar (2013) states that all these factors supported the country to
attract more and more investors from another country who invest in financial assets of the
country and as a result of which it helps in increasing the flow of foreign currency that further
contribute toward increasing the capital in the banking sector.
2.3 Review of Empirical Literature
Banking Sector Development can have a significant impact on the economic growth and
structure of an economy. Tongurai and Vithessonthi (2018) in their research paper that analyses
the effect of the Banking Sector on Economic Structure and Growth explain that agricultural and
industrial sectors tend to have a negative and positive impact on economic structure,
respectively, and growth only for those countries where a high level of banking sector
development is found. By negative implications, one means that a high degree of banking sector
development may concentrate on the growth of only one sector at the expense of another such as
Agriculture Development of Nigeria. It has been observed by the two scholars that agriculture
sector growth is adversely impacted when there is a high degree of Banking Sector Development
present in an economy.
As Industrial Sector goes hand in hand with Banking Sector Development, the former tends to
have a positive impact on the latter as observed by Tongurai and Vithessonthi (2018). The
relevant research paper attempts to explore the importance of financial capital allocation,
specifically to investment activities giving high returns. The author considers seven regions as its
sample viz. East Asia and Pacific; Europe and Central Asia; Latin America and the Caribbean;
the Middle East and North Africa; North America; South Asia and Sub-Sahara Africa. For
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drawing inferences as well as evaluating outcomes, macro-economic data has been collected for
1960 to 2016 from Datastream and World Databank. For quantifying industrial development, a
calculation of value added based on the industry sector has been considered, which comes as a
percentage of Gross Domestic Product (GDP). Here, Global Economy (2019) explains that the
Gross Domestic Product is calculated as the total gross value of goods and services produced by
the residents of Nigeria plus any tax paid on products minus any subsidies not included in the
value of such products. However, for measurement of agricultural development, a percentage of
GDP has been chosen. The proxy, here, consists of a share of domestic credit growth to private
and financial sectors in the form of percentage of GDP mainly depository financial institutions
which indicate the relative size of the banking system.
Using an Ordinary Least Square (OLS) Method, Tongurai and Vithessonthi (2018) aim to
articulate the effects of the banking sector development on the leading industrial and agricultural
sector. Based on univariate analysis and correlation and regression analysis, the empirical results
show that inflation and real interest rates are highly correlated. This means that any change in
inflation would substantially affect real interest rates prevalent in the seven regions. In the
Nigerian Context, this would hold as the economy is mainly based on the mining industry, with a
more advanced banking system the economy would be able to further its economic goals as well
as industrial development. Hence, the development of the banking system is of paramount
importance for Nigeria. This can be achieved, as suggested by the research conducted, through
the modernisation of their overall banking systems and credit creation policies. The inferences
drawn by the authors in their research paper also indicate that there is no significant impact on
the agriculture sector due to banking development. In addition to this, there is a unidirectional
relationship between banking development and its impact on the industrial sector.
Looking at the financial development, real output and economic growth, Ductor and Grechyna
(2015) in their research found that there is an optimal level of financial development experienced
by a given economy based on the characteristics or macro-economic variables. Economic growth
is dependent on various factors; one of the main factors affecting it is financial development.
Nyasha and Odhiambo (2018) observe that financial development is one of the major
determinants that broadly impact how economic growth occurs in an economy. In the context of
the Nigerian Economy, the real sectors include primary, secondary and tertiary segments. Under
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these, the Primary industry is concerned with the production and extraction of natural resources
such as mining which is one of the major industrial sectors of Nigeria and Africa, as a continent.
Similar to Tongurai and Vithessonthi (2018), this paper also assumes that better allocation of
financial resources results in sustainable and balanced growth of the economy across all sectors.
As economic growth cannot solely be dependent on a single industry, it is crucial to understand
at what relative speed financial development affects a diverse set of sectors. If the rate of change
is higher for one industry and negative for another, the overall change would ultimately be
nullified for the two, thus, resulting in a little or no change felt in the economy in terms of
economic growth. Ductor and Grechyna (2015) take private credit extended by the banks into
consideration as a share of Gross Domestic Product (GDP) and liquidity while accounting for the
level of financial development occurring in a developed or developing country.
The data used by Ductor and Grechyna (2015) to denote the interrelationship between financial
as well as real sector development and economic growth includes a panel comprising of 101
countries for a time-frame chosen to be 1970 to 2010. This sample has been collected from the
World Development Indicators (WDI) Report published by The World Bank. The results
indicate that the economic growth rates against financial development have a non-linear
relationship, whereby there is positive relationship as long as the rate of development is low. On
the other hand, there is a negative impact experienced for higher levels of financial development
experienced in an economy. On the other hand, there is a negative impact experienced for higher
levels of financial development experienced in an economy. Taking a ratio of financial
development and GDP, Nigeria comes at a really low position. This has been illustrated in the
image in the Appendix. In addition to this, Tongurai and Vithessonthi (2018) infer that a cross-
sectional strategy has been undertaken which employs OLS method to determine the long-term
relationship between financial development, real sectors and Gross Domestic Product (GDP). It
is inferred that financial development adversely affects economic growth when private credit
maturation is more than industrial output and vice versa. It is also obtained that a balanced
growth would accelerate the economic growth of an economy as and when financial
development takes place.
For Nigeria, this is an important point to be taken into consideration. The Banking Credit
provided by the economy needs to be in balance with its real sectors, mainly the mining industry
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as any positive and sustainable financial development occurring in this market would lead to the
sustained growth of the economy as well. Agbanike et al. (2018) state in the research that
Nigerian policymakers believe credit creation inputs can help in generation of productivity in the
economy which can be achieved by the promotion of specific economic activities by loaning
amount to producers. The authors look at the diverse sector-level lending structure of Nigeria's
Commercial Institutions operating in banks loans and advances for the period between 1981 and
2014. Agbanike et al. (2018) found that a total of N75561.82bn of credit was loaned out between
this time-frame as depositories.
One of the earlier studies by Zellner (1962) examined the effect of bank credit on economic
growth in Nigeria and the main sectors focused were Agriculture, Commercial, Industrial, Real
Estate and Construction. The results showed that even though the bank credit contributed
differently to the overall economic growth of Nigeria, there was not a substantial impact on the
economic growth by bank credit in isolation. The findings recorded in this study shows that there
is 74.6%, 66.7%, 49.4%, 51.3%, and 43.7% variations in economic growth for agriculture,
commercial, industrial, real estate and construction industries respectively that have been
explained by selected independent variables of bank lending, interest rates, exchange rate and
human capital. Through the implementation of the banking credit in the Nigerian Economy, it is
also ascertained that the highest impact on economic growth by the agricultural sector amounted
to only 3% of total bank credit. On the other hand, the service sector had no significant effect
even though this segment received a 53% contribution out of total bank credit extended by
Nigerian Banks. The research paper also concludes that as far as the extension of credit by banks
affecting the economic growth of Nigeria is concerned, any aggregation of credit for all sectors
through one criterion can lead to misrepresentation of the analysis. This is because there are
sectoral differences.
Literature Review Summary
One can identify a gap as per the studies and evidence collected through the empirical literature,
which is about the impact of banking sector development on economic growth. Some of the
results provided by previous scholars state that the banking sector development has been
positively impacting the industrial sector and economic growth of developing countries such as
India and Nigeria, whereas some evidence that there is hardly any impact of banking sector
development on economic growth (Tongurai and Vithessonthi, 2018). Therefore, this research
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will further analyse the impact of banking sector on economic growth (or GDP growth) of
Nigeria over 1990-2017. The next section covers the methodology of this study explains sample
and data.
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