Financial liberalization and price rigidity in the Nigerian banking system

Abstract

Purpose Many developing countries embarked on a program of financial liberalization in order to maximize the benefits associated with a free market system. The preponderance of the evidence in the financial economics literature is that market‐determined interest rates become volatile subsequent to financial liberalization. This paper aims to examine the liberalization program in Nigeria with a view to finding out whether the level of banking competition is increased after financial liberalization. Design/methodology/approach The test of banking competition is premised on the argument by Hannan and Berger that retail interest rate rigidity results from either market concentration or the size of the customer base. The cointegration and error correction models are applied to quarterly wholesale and retail interest rates from 1987 through 2001, in order to analyze their long‐run as well as short‐run dynamics. Findings The retail lending and deposit rates possess a long‐run equilibrium relationship. Moreover, the minimum rediscount (wholesale) rate (MRR) and the deposit rate also exhibit a long‐run equilibrium relationship. If the lending and deposit rates diverge from their long‐run equilibrium relationship, 37 per cent of the disequilibrium is corrected each quarter by changes in the lending rate. On the other hand, any disequilibrium in the long‐run relationship between the deposit and MRRs can be corrected by changes in the MRR at about 58 per cent per quarter. Originality/value The results imply that the financial liberalization in Nigeria failed to achieve its key objective of a market‐driven interest rate system.

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