FINANCIAL DEEPENING AND ECONOMIC GROWTH IN NIGERIA.
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FINANCIAL DEEPENING AND ECONOMIC GROWTH IN NIGERIA.
Chapter one
1.1 Introduction
Financial deepening is the process of developing and expanding financial institutions such as banks, stock markets, and insurance companies in proportion to the size of a country’s economy. It also refers to the increased availability of financial products and services with a broader range of options for all levels of society.
A strong financial system is critical to a nation’s economic development. It promotes economic growth by mobilising and allocating financial resources efficiently, as well as providing a well-functioning payment/fund transfer mechanism.
One of the reasons driving quick and persistent economic growth in middle and high-income countries (Mexico and Venezuela, the United Kingdom, and the United States of America, respectively) has been their well-established financial sectors.
On the other hand, one of the most typical features of low-income countries is poor financial system performance. A financial sector’s health and performance can be measured using macro-indicators such as the monetary assets to GOP ratio, currency to money ratio, deposits ratio, interest rate spread, money multiplier, and so on.
Financial deepening or depth is defined by the following characteristics: less use of cash, i.e. an increase in the level of non-cash payments and fund transfers, decreasing velocity of money and capital markets, competitiveness and specialisation in financial functions and institutions
a high and stable ratio of money supply (broad money) to GDP, and low premiums on savings and lending rates, among others. The following indexes have been used to measure the amount of financial deepening.
1.1.1 Money-to-GDP Ratio
This is a strong indicator of financial sector deepening. It denotes the ratio of monetary assets in the economy to GDP. It measures the level of liquidity in the financial system as well as its potential to finance economic growth.
Thus, a country with a greater money-to-GDP ratio will have a more developed and efficient financial industry. Economic units will only create monetary assets/instruments that they believe are convenient in terms of liquidity, risk, return, and payment efficiency.
Such money instruments will only be available from a well-developed financial sector. More developed countries have a greater money-to-GDP ratio than low-income countries.
A financial sector with a greater money/GDP ratio can thus supply more cash for investment than a financial system with a lower money/GDP ratio.
1.1.2 Currency Ratio.
This is the proportion of money in circulation to monetary assets. A low currency ratio indicates that the financial system is efficient and has a high level of intermediation. It also indicates the efficiency of the financial system in mobilising savings, as well as the presence of an inefficient payment system.
This ratio is often low in middle and high income countries and decreases over time, but it does not exist in underdeveloped countries because a major portion of the money in circulation is in the form of liquid cash (currency).
1.1.3 Money Multiplier
The money multiplier measures how responsive the money supply is to changes in the monetary base (the total amount of currency circulated in the hands of the public or in commercial bank deposits held in the central bank’s reserves).
It serves as an indicator of financial deepening by demonstrating the monetary authority’s ability to adjust the total amount of money in circulation using the monetary base.
1.1.4 Market Capitalization to GDP Ratio
This provides insight into the level of capital market development in an economy. The capital market is where long-term money are raised for investment purposes.
The capital market’s market capitalization is calculated by multiplying the price of each listed stock by the total number of outstanding (issued) stocks.
Thus, the ratio measures the capital market’s ability to deliver the money required for investments and economic growth; the higher the ratio, the more developed the financial sector and the greater the impact of capital market intermediation activities on economic growth.
1.1.5
M2 is a category of money supply that comprises M1 as well as any time linked deposits, savings deposits, and non-institutional money-market funds.
This is one of the most commonly used indicators of financial depth. The higher this ratio, the more developed the financial industry is. This indicator, however, has a limitation when used to assess the amount of financial sector development.
This measure, however, has a shortcoming when used to measure the level of financial deepening for developing economies with a cash-based payment system.
An increase in the M2/GDP ratio could be caused by an increase in currency outside the banks, resulting in the ratio measuring the level of liquidity preference rather than financial depth.
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