EFFECT OF PUBLIC DEBT ON BANKING SECTOR PERFORMANCE IN NIGERIA, 1995-2016

ABSTRACT

This study sought to achievethe following objectives: (i)investigate the impact of federal government’s external borrowings on the lending rates of deposit money banks in Nigeria, (ii) determine the effect of federal government’s domestic borrowings on commercial banks total deposit  liabilities  in  Nigeria,  (iii)  examine  the  effect  of  federal  government’s  domestic borrowings  on  commercial  banks  total  credit,  and;  (iv)  evaluate  the  effect  of  federal government’s domestic borrowings on the total assets of commercial banks in Nigeria. The study adopted ex-post facto research design. It was conducted using 16 year annualized time series data spanning the period,1995-2016. Data were generated from the Central Bank of Nigeria Statistical Bulletin. Four research hypotheses were formulated in the process of the research as follows: (i) Federal Government’s external borrowings had no positive and significant effect  on the lending rates of deposit money banks in Nigeria, (ii) There was no significant positive effect of Federal Government’s domestic borrowings on the commercial banks total deposit liabilities in Nigeria, (iii) Federal government’s domestic borrowing did not have a significant positive effect on commercial banks’ total credit in Nigeria, and (iv) federal government’s domestic borrowing did not have a significant positive effect on the total assets of commercial banks in Nigeria. The dependent variable for the four hypotheses was the banking sector performance measured by commercial Banks lending rates, their deposit liabilities, their total credits, and their total assets. The explanatory variables weregovernment external debt components for hypothesis one and government domestic debt components for hypotheses two to four. The four hypotheses were tested at 5% level of significance via IBM computer-based bi-variate linear regression model using the current statistical package for social science (SPSS)version 20. Findings show that there  wasno  significant  positive  effect  of  federal  government’s  external  borrowings  on  the lending rates of deposit money banks in Nigeria; there was significant positive effect of federal government’s domestic borrowingson commercial banks total deposit liabilities in Nigeria; Government’s domestic borrowing hadasignificant positive effect oncommercial banks’ total credit in Nigeria; and Federal government’s domestic borrowing had a significant positive effect on the total assets of commercial banks in Nigeria. Considering the findings, the following recommendations are made: Government should reduce her financing expenditure using external debt and should rather adopt more of domestic debt financing strategy as servicing external debt have been found to be more expensive. Secondly, the presence of a well-functioning autonomous domestic debt market could help reduce the rate at which government borrows from outside, therefore, such robust domestic debt market should be established in Nigeria.

CHAPTER ONE

INTRODUCTION

1.1       BACKGROUND TO THE STUDY

Generally, debt refers to the resources of money in use in either public or private organization which is not contributed by its owners and does not in any other way belong to them. It is a liability which could be represented by a financial instrument of other formal equivalents. When a government borrows, the debt is a public debt. According to Udoka and Ogege (2012), public debt constitute that amount of money owned by the government to institutions, government agencies and other bodies resident in or outside Nigeria. Again, public debt are debt owe by the government internally or externallywhether interest-bearing or notand include bank-held debt andgovernment currency, if any; less any claims held by the government against the private sectorand foreigners. External debt as documented in Eleje, et.al., (2012) compriseobligations the government owe to multilateral bodies, London Club, Paris Club, foreign promissory notes and other unclassified external borrowings. On the other hand, Nigeria’s domestic debt is defined mainly as debt instruments by the federal government and denominated in local currency. It consists mainly of Nigerian Treasury Bills, Nigerian Treasury Certificates, Treasury Bonds, Federal Government Development Stocks, Ways and Means, and recently considered are Contractor debts(Central Bank of Nigeria, 2010;Adofu and Abula, 2010; and Obademi, 2012).

Public debt oftentimes results in economic hardship or burdenif not managed appropriately. The hardship may take the form of waste of productive efficiencyfor the economy as a whole or undesirable economic burdensimposed upon particular classes. The debtburden in Nigeria has resulted in various distortions in the macroeconomy. Essentially, thesedistortions are structural in nature, and thus affect the level of per capita incomes and areinstrumental to the rising poverty in

the country (Nzotta, 2004).The latter has attracted the attention of variousauthors and Nigerian economic planners.

A  country’s  debt  structurecould  affect  her  individual  citizens,  institutions  of  government, privately owned corporate organizations like banks and consequently the economy at large. The debt structure in this context is the magnitude of the domestic debt as well as the magnitude of the external debts. The issue of Nigeria’s public debt became important in recent times especially prior to the period of the debt forgiveness because of its magnitude and the amount which was required to service such debts as well as its attendant possible effects on different operating sectors of the economy especially the banking sector and the growth of the economy at large. As at year end,December 2005, Nigeria external debt was N2,696 Trillion of which about N2,029Trillion or 85% was owed to the Paris club of fifteen creditor nations.

Apart from external debts, Nigeria’s aggregate domestic debt as at 31st December, 2005 was N1,275 Trillionof which about N801B or about 63% was owed the banking institutions  as reported by the debt management office (DMO, 2006). According to Obademi (2012), three reasons have been advanced for such growing government debt. First, government borrowed to finance emergencies such as natural disasters and economic depression. Secondly,government borrowed to finance important capital projects such as water dams, agricultural development projects, river basin development projects; and thirdly,she borrowed to finance current expendi- ture in anticipation of reasonable revenue collection.

The genesis of the market for public debt in Nigeria was the financial reforms introduced by the colonial government in 1958 which led to the creation of the Central Bank of Nigeria and the creation of marketable public securities to finance anticipated fiscal deficits. The Central Bank of

Nigeria ordinance 1958 explicitly stated inter alia that: “the Bank shall be entrusted with the issue and management of federal government loans publicly issued in Nigeria, upon such terms and conditions as may be agreed between the federal government and the Bank”. To the ordinary man however, public debt evidenced in budget deficit might not make sense. But different governments since independence have used budget deficit as a means of fostering policy agenda as occasion demands.

1.2       STATEMENT OF THEPROBLEM

Notable researchers and concerned academics like Islam and Biswas (2005), Onyeiwu (2012), Udoka and Ogege (2012)are yet to agree on the roles of public debt in economic development. While some argue that public debt is a credible instrument of growth and effective economic performance, others dismiss such position insisting that public debt rather triggers debt crisis andworsens economic situations.Drine and Nabi (2009), in agreement with the debt cycle thesis proposed by Avramovic (1964),argue that external debt is an important funding source for an economy characterized by low domestic savings. According to them, domestic savings in the long run should increase to finance a higher proportion of investment and to repay the external debt contracted in the first stage of development. But Obademi (2012) consistent with Krugman and Proot (1989) showed that there is limit to which debt accumulation stimulate investment and growth. He documents that at high levels of indebtedness, growth and investment would only improve if part of the current debt service obligations of a debtor country were forgiven.

On the other hand, studies including Islam and Biswas (2005), Onyeiwu (2012), Udoka and Ogege (2012) amongst others hold that public debt has negative effect on economic growth. They argue that high public debt leads to high taxes and puts upward pressure on real interest rates,  which  may  crowd  out  private  investment.Onyeiwu  (2012)  particularly  document  that

domestic debt holding of government was far above a healthythreshold of 35 percent over the period of his study presenting evidence of crowding out of private investments.

As the aboveuniversal debate is yet unsettled,there is presently another widespread argument in respect of the developing nations that excessive public indebtedness of these countries is a major impediment to their growth and stability. Recent studies including Bolle, et.al., (2006),Guscina and Anastasia, (2008), and Eleje, et.al., (2012), have documented that developing countries have contracted large amount of external debts, often at highly concessional interest rates particularly in the 1970s and 80s. The hope was that these loans would put them at faster development path through higher investment and faster growth. But as debt service ratios reached very high levels, it became obvious that for many of these countries, debt repayment becamemajor constrain to their economic performance.

Meanwhile, an extensive body of literature have attempted to examine how the structure of public debt could affect the stage of national development in a country and how fiscal policy and the resulting level of debt could affect macroeconomic stability (Audu, 2004; Reinhart and Rogoff, 2009; and, Udaibir, et. al., 2010). While most of these studies explicitly acknowledged the role of proper management of public debt in promoting overall economic growth of nations, major sectorial evidencesuch as the effect of public debt on the banking sector is still inadequate. This means that there is still a research gap that needs to be covered in this direction. Moreover, even in situations where research evidence exist, majority of the studies used data from the developed nations. The studies therefore could not capture the socio-political and business environmental differences in the developing countries.In Nigeria today, there is this popular opinion although lacking in empirical validation that external debt overhang is one of the major factors that has contributed largely to the poor bank credit accessibility by businesses due to

associated high interest rates within the last decade. This study is therefore an attempt to fill these research gaps.

1.3       OBJECTIVES OF THE STUDY

This research generally appraises the effects of public debt on the performance of the banking sector in Nigeria. Specifically, the study is set toachieve the following objectives:

i.      To investigate the impact of federal government’sexternal borrowings on the lending rates of deposit money banks in Nigeria,

ii.      To determine the effect of federal government’s domestic borrowings on commercial

banks total deposit liabilities in Nigeria,

iii.     To  examine  the  effect  of  federal  government’s  domestic  borrowings  on  commercial

banks total credit, and;

iv.      To evaluatethe effect of federal government’s domestic borrowings on thetotal assets of commercial banks in Nigeria.

1.4       RESEARCH QUESTIONS

Based on the statement of research problem and the objectives of the study, this researchwill answer the following questions:

i.      To what extentdidthe federal government’s external borrowings affect the lending rates of deposit money banks in Nigeria?

ii.     To  what  extent  didthe  federal  government’s  domestic  borrowings  affect  commercial

banks total deposit liabilities in Nigeria?

iii.     To  what  extent  didthe  federal  government’s  domestic  borrowings  affect  commercial

banks total credit in Nigeria?

iv.      How far had the federal government’s domestic borrowings affected the total assets of commercial banks in Nigeria?

1.5       RESEARCH HYPOTHESES

Arising from statement of the problem, the research objectives, and the research questions, the following null hypotheses are formulated to guide the study:

i.      Federal government’s external borrowings had no positive and significant effect on the lending rates of deposit money banks in Nigeria.

ii.      There wasno significant positive effect of federal government’s domestic borrowings on

the commercial banks total deposit liabilities in Nigeria

iii.       Federal government’s domesticborrowing did not have a significant positive effecton commercial banks’ total credit in Nigeria, and;

iv.      Federal government’s domestic borrowing did not have a significant positive effecton the total assets of commercial banks in Nigeria.

1.6       SCOPE OF THE RESEARCH

The timeframe for the analysis of this study will be the period 1995 – 2016. This is a twenty two (22) year period which will cut across the pre-debt cancellation era and the post-debt cancellation era. It could be recalled that in June 2005, following an initial move by the federal house of representative, a deal on Nigeria debt reduction emerged from the Paris club which led to the cancellation of 60% of Nigeria’s bilateral debt amounting to $18 billion (Webbler, 2007). The need to empirically evaluate the performance of the banking sector following the debt relief among  others  informed  the  choice  of  this  period  of  study.  The  study  therefore  will  be

comparative in nature and as such will be divided into two periods viz;eleven years before debt cancellation and eleven years after debt cancellation respectively.

1.7       SIGNIFICANCE OF THE STUDY

This study will be of immense benefits to several groups of people including the government, banks and other financial institutions, business organizations and academics in diverse ways:

Government: The result of this study will aidthe federal government review its policies on external debt and adopt more of domestic debts, as servicing of external debt appears to be expensive.This will also improvethe implementation of the monetary and fiscal policy. It will serve as aguide to the government on budgetary allocations, debt management as well as management and control of budget deficits to ensure effective regulations of macroeconomic factors like inflation rate amongst others.

Banks and Other Financial Intermediaries: Banks and other financial intermediaries are expected to profit significantly from the outcomes of this research. The study will enable banks and  other  financial  intermediaries  have  indepth  knowledge  of  the  effect  of  government borrowings on their deposit liabilities, assets, and their overall performance. Consequently, it will enable  them  to  device  appropriate  negotiation  strategies  with  the  government  monetary authorities as occassion demands.

Financial Market Regulators: The research will also provide required empirical and theoretical base concerning the effects of government debt to financial market regulators like the Central Bank of Nigeria (CBN), Ministry of Foreign Affairs, Debt Management Office, amongst others. Such insight will offer useful guide to these regulators in designing appropriate regulations for the economy.

Policy Analysts and Reading Public: The outcome of this research is also expected to be of significance to policy watchers and analyst. This group of people will utilize the platform of this study in their analysis on public debt and financial market performance in Nigeria. Similarly, the general public, through the findings of this research, will be better informed on the level, nature and impacts of government’s domestic and external borrowings on the Nigerian economy.

Academics: Academically, this study will contribute to the enrichment of literature on debt management in Nigeria. It will empirically establish the significant impact of public debt on banking sector performance. The study is expected to provide important information to guide future researchers.

1.8       OPERATIONAL DEFINITION OF TERMS

Debt Structure:         This is the composition of debt instruments and their maturities (Bolle, et.al.,

2006)

Domestic Debt:         The proportion of government debt or borrowing incured  internally such as treasury bills, bonds, etc (CBN, 2009).

Economic Growth:  This is a rise in the productive capacity of a nation on a per capita basis. It involves the expansion of the economy on a simple widening process (Eleje, Nwokeji, and Onwumere 2008/09)

External Debt:          The proportion of government debt or borrowing incured outside the country such as Paris Club loans, London Club loans, etc (CBN, 2009).

Financial stability: Financial stability relates not only to the absence of financial crises but also  to the inherent ability of the financial system to avoid, contain, and deal with imbalances that could pose a threat to the system or to economic processes (Guscina and Anastasia, 2008).

Per Capita Income: This is a measure of mean income within an economic aggregate such as acountry or city. It is calculated by taking a measure of all sources of income in the aggregate such as GDP or GNI and dividing it by the total population (Wikipedia, 2012).

Performance:            This is the accomplishment of a given task measured against preset known standard of accuracy and  completeness.  To  a business  organization,  it implies the results of activities of the organization or investment over a given period of time (Hornsby, 2006).

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