IMPACT OF INTEREST RATE DEREGULATION REGIME
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IMPACT OF INTEREST RATE DEREGULATION REGIME
Chapter one
1.0 Introduction
1.1 Background of the Study
The banking business is commonly recognised as one of the most severely regulated sectors in both developed and emerging nations. Banks, as financial intermediaries, help to move funds from surplus economic units to deficit ones, so facilitating business transactions and overall economic development.
Bank interest rates were regulated to encourage saving and assure appropriate investment for rapid economic expansion. The presence of market imperfections and externalities in financial markets, particularly in developing countries, has frequently resulted in official intervention not only to increase investment, but also to shift credit distribution within the economy.
Deregulation of interest rates in the banking business entails the deliberate removal of regulatory regulations, structures, and operational standards that may be deemed impediments to orderly growth, competitiveness, and effective resource allocation in the banking industry.
Financial markets were among the first sectors of the economy to be deregulated. Many industrialised economies have strongly pursued financial market deregulation.
In recent years, a number of third-world countries with high debt burdens and declining foreign profits have implemented policies aimed at deregulating their economy, notably the financial markets sub-sector.
This has essentially been carried out as part of a comprehensive Structural Adjustment Programme (SAP) intended at ensuring that market forces play a larger role in the allocation of limited financial resources.
As part of the Structural Adjustment Programme (SAP), Nigeria has begun deregulating its banking system. It was introduced into the Nigerian economy in 1986, during General Babangida’s administration.
The initiative began in earnest with the liberalisation of interest rates, commerce, and currency rates, as well as the deregulation of bank interest rate policies.
Prior to the implementation of SAP, the banking system was subject to strict administrative control, and the economy was characterised by severe structural distortions caused by the oil commodity (crude oil), which accounted for more than 90% of the country’s foreign exchange earnings and more than 80% of total government revenue. There existed an import syndrome, which resulted in a heavy reliance on imports for both consumer and producer goods.
To reverse this tendency, rigorous exchange control and import restriction measures, including a comprehensive import licencing regime, were implemented.
However, as the crisis progressed, it became clear that previous ad hoc initiatives were ineffective in bringing about the necessary change in the economy, necessitating a major structural adjustment of the economy. As a result, the structural project was implemented in July 1986.
The overall goal of the Structural Adjustment Programme (SAP) was to remove the recognised distortions in the Nigerian economy. Specifically, its objectives are:
i. Restructuring and diversifying the production basis of the economy to lessen reliance on the oil sector and imports;
ii. To provide the groundwork for sustained non-inflationary or moderate inflationary growth;
iii. To achieve fiscal and balance-of-payments viability throughout the period;
iv. To improve sector efficiency and increase the private sector’s growth potential.
With the implementation of the Structural Adjustment Programme (SAP) in the Nigerian economy, there has been a surge of interest in the operations and advancements of the banking system.
A significant component of the SAP was the restructuring of the national financial system, which involved loosening various restrictions that were deemed detrimental to the system’s expansion.
The Central Bank of Nigeria (CBN) was founded in 1959 to monitor banks and prevent large-scale bank failures. Since its founding, the CBN has played a significant role in setting the groundwork for the establishment of the Nigerian Deposit Insurance Corporation (NDIC) in 1988.
Banks are really important. In the economic development of any country. Schumpter (1934) identifies the financial system as a significant agent in the development process.
The Central Bank of Nigeria (CBN) generally fixed interest rates until the third quarter of 1986, with adjustments based on government sectoral priorities. The active interest rate policy began when banks were allowed to negotiate interest rates on time deposits.
Interest rates were further deregulated in August 1987, when the Minimum Rediscount Rate (MRR) was raised. Also in 1988, the Minimum Rediscount Rate (MRR) was increased. The rate of interest growth was mild in 1990, as commercial and merchant banks’ liquidity improved.
In 1992, the maximum differential between banks’ average cost of funds and lending rates was raised higher. The increase in bank interest rates was caused by a total deregulation of interest in the year’s budget. The market interest rate rose steadily throughout 1993.
In light of the aforementioned, this article evaluates the impact of the interest rate deregulation regime on the real sector of the Nigerian economy (1985–2010).
1.2 Statement of the Problem
In August 1987, the Central Bank of Nigeria (CBN) implemented a market-based interest rate policy as part of the overall framework of deregulating the economy in 1986 to improve competition and resource allocation efficiency.
The choice was not without debate. While it was generally acknowledged that low interest rates did not stimulate saves, there was concern that high interest rates, which were likely to precede deregulation, would slow investment.
The deregulation of interest rates enabled banks to set deposit and lending rates based on market conditions via discussions with their clients.
Interest rate changes can have a major impact on other macroeconomic indicators. The rising interest rates will encourage savers to obtain higher returns.
However, interest payments account for a large share of production costs. Increased interest rates may limit investment, output, and employment in the sector of the economy.
Higher interest rates could deteriorate the balance of payment’s current account situation due to higher capital inflows from abroad, pressures on the native currency, and lower demand for locally produced goods and services. The domestic economy would suffer from reduced output and employment.
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