Financial liberalization and price rigidity in the Nigerian banking system O. Felix Ayadi and Ladelle Hyman
Jesse H. Jones School of Business, Texas Southern University, Houston, Texas, USA Abstract
Purpose – Many developing countries embarked on a program of financial liberalization in order to maximize the benefits associated with a free market system. The preponderance of the evidence in the financial economics literature is that market-determined interest rates become volatile subsequent to financial liberalization. This paper aims to examine the liberalization program in Nigeria with a view to finding out whether the level of banking competition is increased after financial liberalization. Design/methodology/approach – The test of banking competition is premised on the argument by Hannan and Berger that retail interest rate rigidity results from either market concentration or the size of the customer base. The cointegration and error correction models are applied to quarterly wholesale and retail interest rates from 1987 through 2001, in order to analyze their long-run as well as short-run dynamics. Findings – The retail lending and deposit rates possess a long-run equilibrium relationship. Moreover, the minimum rediscount (wholesale) rate (MRR) and the deposit rate also exhibit a longrun equilibrium relationship. If the lending and deposit rates diverge from their long-run equilibrium relationship, 37 per cent of the disequilibrium is corrected each quarter by changes in the lending rate. On the other hand, any disequilibrium in the long-run relationship between the deposit and MRRs can be corrected by changes in the MRR at about 58 per cent per quarter. Originality/value – The results imply that the financial liberalization in Nigeria failed to achieve its key objective of a market-driven interest rate system. Keywords Nigeria, Financial restructuring, Financial modelling, Stability (control theory), Integration Paper type Research paper
Introduction In the 1980s, several developing countries pursued some form of financial liberalization program or the other, in order to boost the development of their economies. The financial liberalization trend is a segment of the broader attempt to reduce the direct control of the economy by regulatory authorities. As Bandiera et al. (1999), note that the wave of liberalization in many developing countries in the 1980s was characterized by more attention given to market forces in allocating credit through freely determined interest rates. Prior to this period, many of the economies relied on the government as a source of discipline for economic agents. However, Demetriades and Luintel (1997) argue that any interference in the financial market through credit rationing thwarts economic development with adverse consequences on the volume and productivity of investment. Another issue that is closely related to market control is tampering with the market mechanism through rent-seeking behavior. The issue of rent-seeking behavior is prevalent in many market-oriented economies where governments impose restrictions on economic activities. In a rent-seeking situation, economic agents are willing to put efforts into securing monopolies or manipulate the machinery of government to impose restrictions on market activities for their benefits. According to Claessens and
Managerial Finance Vol. 32 No. 7, 2006 pp. 557-568 # Emerald Group Publishing Limited 0307-4358 DOI 10.1108/03074350610671557
Klingebiel (2001), this behavior absorbs huge resources and lead to sub-optimal wealth redistribution. Moreover, rent-seeking behavior imposes costs on the society. The importance of the financial system to economic development is not quite clearcut. Some researchers such as Hicks (1969) hold the view that the financial system...