EFFECT OF SAVINGS ON INTEREST RATE IN NIGERIA (1981-2013).
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EFFECT OF SAVINGS ON INTEREST RATE IN NIGERIA (1981-2013).
Chapter one
INTRODUCTION
1.1. Background of the Study
The financial system has long been recognised as playing an important role in economic development. The benefits of a healthy and developed financial system include increased savings and effective financial intermediation functions.
The benefits of financial intermediation between savers (lenders) and borrowers include risk dispersion and lower transaction and search costs. Financial institutions provide liquidity to the economy by borrowing short-term and lending long-term.
These financial intermediaries boost the economy by diversifying its assets. They mobilise savings from atomized individuals for investment, so addressing the issue of indivisibility in financial transactions.
Consequently, mobilised savings are invested in the most profitable companies, regardless of the source. The extent to which this is possible is determined on the level of development in the financial sector and the population’s saving habits.
According to these expectations, Nigeria has implemented financial liberalisation under various financial architecture and macroeconomic conditions.
The availability of investible capital is thus viewed as a prerequisite for any economic investments that will finally result in economic growth and development (Uremadu, 2006, cited in Olayemi & Michael, 2013).
Mckinnon and Shaw (1973, as referenced in Onwumere et al., 2012) blamed financial restrictions for developing countries’ poor development performance.
They went on to explain that financial repression occurs primarily when a government imposes nominal deposit and lending interest rate ceilings that are low in comparison to inflation.
Savings are the part or fraction of disposable income that is not spent on current consumption. It includes bank time deposits as well as numerous types of shares.
According to Keynesian economics, saves is the amount left over after subtracting the cost of a person’s consumer expenditure from his or her disposable income in a specific period of time.
Financial institutions such as deposit money banks (DMBs) and commercial banks mobilise savings deposits and pay interest on them. Interest rates are an essential economic price because of their broad role in the economy. Whether viewed through the lens of cost of capital or opportunity cost of funds, they have a fundamental impact on the economy.
Interest rates on savings accounts contribute to the more reasonable availability of funds in the bank rather than at home. Saving money in a bank account usually results in some sort of reward depending on how long the money is kept there.
Interest rate refers to the direct benefits or returns that money gets while in a bank account. The interest rate is defined as a payment for the usage of capital or money. Keynes saw interest rates as solely monetary phenomena, payment for the use of money.
It is the prize for giving up the liquidity of money. Thus, a premium is provided to wealthy individuals in order to entice them to part with their cash. When people refrain from consuming, they save, and the interest rate becomes an incentive for saving. Interest rate can be viewed as a reward for saving.
Interest rates boost savings when the cost of capital and credit availability are influenced; if interest rates are administratively established, they are known as fixed interest rates, and if they are determined by market forces, they are known as floating interest rates.
To efficiently mobilise savings in an economy, the deposit rate (interest rate) must be relatively high while inflation is stabilised to provide a high positive real interest rate, which encourages investors to save from their disposable income. In Nigeria, the difficulty of mobilising savings has hampered economic growth and progress.
Since the oil shock in Nigeria in the early 1990s, savings mobilisation has been dropping. However, this tendency conceals a significant and growing disparity in saving rates, particularly among developing countries.
Savings behaviour varies greatly across countries and across time, reflecting disparities in development levels, growth performance, and fiscal and financial policy.
The interest rate reform policy of financial sector liberalisation was required to address the issues generated by financial oppressive measures. Since the introduction of the concept of financial liberalisation in the 1970s, many countries such as Angola, Burundi, Congo, Cote d’lvoire, Gambia, Chana, Kenya, Madagascar, Malawi, Mozambique, Nigeria, Rwanda, Tanzania, Zambia, Zimbabwe, India, China, Turkey, etc.
have made attempts to liberalise their financial sectors by deregulating interest rates, eliminating or reducing credit controls, allowing free entry into the banking sectors, giving autonomy to commercial banks.
According to Odhiambo (2009), of the six elements of financial liberalisation, interest rate liberalisation appears to have received the most attention. In Nigeria, financial sector reforms began with the deregulation of interest rates in August 1987 (Olayemi & Michael, 2013).
Prior to this period, in the early 1980s, the financial sector was subject to financial regulation, and interest rates were stated to be repressed (set) by the Central Bank of Nigeria (CBN) based on policy decisions.
The primary goals during this time period were to achieve optimal resource allocation in order to encourage orderly growth in the financial system and facilitate the flow of credit to preferred sectors such as agriculture and manufacturing (Soludo, 2008). During the period of fixed interest rates, real interest rates were typically negative.
It causes financial disintermediation, which results in low levels of savings, direct investment, and growth. Funds were insufficient due to an overall economic slowdown, with monetary and credit aggregates moving slowly.
As a result, the financial industry faced ongoing pressure, necessitating financial system liberalisation. Financial repression resulted in low or negative interest rates, discouraging savings mobilisation and directing those savings through the financial system.
This has a detrimental influence on the quantity and quality of investment, resulting in slower economic growth. As a result, interest rate change was expected to boost savings while also making loanable funds available to banks.
However, in a major policy turnaround, the government unilaterally implemented certain regulatory measures in interest rate management in January 1994. According to the CBN (2010), complete deregulation of interest rates resulted in ‘wide variances and needlessly high interest rates’.
Banks were free to set deposit and lending rates based on market forces through talks with their customers (Soludo, 2008; Nwachukwu & Odigie, 2009). Interest rates soared following the financial sector’s liberalisation (Soludo, 2008).
What is uncertain is whether there will be a substantial response in savings when interest rates rise. These, among others, pique the researcher’s curiosity in the relationship between interest rates and saving in Nigeria.
1.2 Statement of the Problem
Over two decades ago, the Nigerian economy saw the implementation of the Structural Adjustment Programme (SAP), which transferred focus from the public to the private sectors.
The goal was to, among other things, encourage private domestic savings, private domestic investment, and capital formation in order to boost economic growth and development, but the level of funds mobilised by banks through the use of interest rates is quite low or has not been very effective for a number of reasons, one of which, according to Nnanna et al (2004), is banks’ attitude towards small savers.
The primary function of interest rates in Nigeria and other countries across the world is to ensure a rate of interest that can induce savings mobilisation in the economy. In Nigeria, the use of interest rates as a savings booster has proven ineffective.
The explanation presented as the cause is that the financial sector is weak. As a result, many people prefer to keep their money outside of the banking system, which they view as shallow and prone to hardship.
Acha (2011) identifies three reasons why saving is not sensitive to interest rates: lack of trust in the banking system, low income, and a preference for cash.
In a similar vein, Ostry and Reinhart (1995) listed the reasons as a lack of knowledge in the domestic financial system, a segment of the population living on or near subsistence income, and liquidity limitations.
The situation in Nigeria echoes the reasons stated above. There are few banks, and they are largely concentrated in urban regions, leaving limited room for actual market setting of interest rates.
According to available data, around 61% of Nigerians live below the poverty line, earning less than $1 per day. Interest rates have no bearing on this group of people because they can barely afford to live, let alone save money.
Despite the legislative measures put in place, such as commercial bank recapitalization, different poverty eradication programmes and policies, and so on, a strong financial system is still a long way off because most people still lack trust in banks.
Furthermore, even those who appear to fully utilise the financial sector’s services are finding it difficult due to the time-consuming nature of the banking process and inefficiency in the banking system, combined with inept corruption, which has continued to taint any success that may have been achieved.
As a result, Nigerian banks have continued to suffer financial difficulties, to the point that some have had to be rescued. To finance long-term economic growth, many developing countries have the difficulty of formulating macroeconomic policies that produce single-digit inflation, sustainable trade and balance of payments deficits, and increased savings and investment rates.
This issue has become more complicated in today’s environment. In light of the stated research challenge, the study broadly attempted to investigate ways to mobilise savings through real interest rates in Nigeria as a means of accomplishing the larger goal of economic growth.
1.3 RESEARCH QUESTIONS.
v How much impact do interest rates have on Nigerian savings?
Is there a causal relationship between interest rates and savings in Nigeria?
v To what extent is there a long-term relationship between interest rates and savings in Nigeria?
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