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Journal of Economics and International Finance Vol. 2(11), pp.251-260 November 2010 Available online at http://www.academicjournals.org/JEIF ISSN 2006-9812 ©2010 Academic Journals

Full Length Research Paper

Exchange rate volatility, stock price fluctuations and the lending behaviour of banks in Nigeria Mbutor O. Mbutor
Research Department, Central Bank of Nigeria. E-mail: mbukor@yahoo.co.uk. Accepted September 9, 2010

Following the recent global economic crisis, so many macroeconomic maladjustments have unfolded in the Nigerian economy. First, the naira exchange rate depreciated sharply and became more volatile than any other time in nearly a decade; the stock market indices have dived very south relative to their previous year's levels and banks, because of their exposure to foreign credit lines, the stock market by themselves and their loan customers- were feared to be on the brink of collapse. Consequently, the Central Bank of Nigeria went to no end of limits to provide liquidity for the banks with a view to forestalling the feared consequences of the crisis. The main concern of researchers and analysts has been to identify the nexus through which the international crisis passed through to the domestic economy. Was the depreciation in the naira exchange rate responsible for the stock market collapse? Or was the reverse the case? Did banks curtail lending because of the depreciation or the fluctuation in the stock indices? This study empirically answers these questions. The vector auto regression (VAR) methodology is applied, treating the data series for temporal properties unit roots and co integration. The impulse response function and the analysis of variance were used to filter the effects of the included variables on bank loans, while the Engel Granger causality confirmed the lines of causation among exchange rate volatility, equity prices and bank loans. Preliminary evidence show that exchange rate volatility and equity price fluctuations affected the behaviour of banks in Nigeria but that the effects were insignificant and that the fluctuation of the stock index caused the naira to depreciate and there was no reverse causality. Changes in bank loans also led to equity price fluctuations and again, there was no evidence of reverse causality. Key words: Exchange rate volatility, global crisis, bank lending behaviour. INTRODUCTION Recent global financial developments, especially the credit crunch and the consequent near collapse of stock markets across the world, have brought to the open the collective vulnerabilities of sovereign economies. Changes in currency prices (exchange rate) are central in transmitting localized economic developments to other geographical domains with regard to its function in transborder trade and investment. Volatile exchange rate regimes blur the predictability of the net worth of banks’ assets denominated in currencies other than the domestic one. It also introduces wide swings in the value of external liabilities, which has consequence for credit creating potentials. In developing countries, banks are principal intermediaries in the loans’ market and as such, exchange rate fluctuations which impact adversely on their balance sheets would reduce the quantity of loans advanced for real activity in the economy. Owing to information asymmetries, depreciation in exchange rate might cause lending to decline in two different ways. First, if such depreciation worsens borrowers’ balance sheets, then the default risk will be enlarged and banks would shy away from making loans. On the other hand, if banks are exposed to short term liabilities in foreign currencies, then such liabilities will be amplified to the tune of the extent of depreciation of the local currency and any other associated costs, thus, dampening their potential to create credit. The stock market tends to mirror the level of confidence in the economy in general and the financial system in particular. It reflects the...
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