Financial Liberalisation and Financial Fragility in Nigeria

Nigeria's financial liberalisation started in 1987 but this was followed by a banking crisis. The experiences of countries such as Nigeria which have experienced banking crises immediately after financial liberalisation have prompted some authors to posit that liberalisation is responsible for financial fragility and banking crisis. Using an index which measures the gradual progression and institutional changes involved in financial liberalisation, this paper conducts an empirical evaluation of the impact of financial liberalisation on financial fragility in Nigeria. The results show that liberalisation has exerted a significant negative effect on financial fragility in both the short run and long run. he Nigerian government embarked upon financial liberalisation as part of its Structural Adjustment Programme (SAP) in 1987 with the belief that freeing up financial markets would help in stimulating economic growth. There was a banking crisis in the immediate aftermath of the financial liberalisation. The deregulation of interest rates in 1993 resulted in a wide increase in the interest rate spread and the increased lending rates made it difficult for small and medium scale enterprises to secure loans. In addition, the relaxation of entry into banking resulted in the widespread establishment of banks which were poorly- managed and stretched the regulatory capacities of the Central Bank of Nigeria (CBN). The banking crisis was at its most severe stage between 1991 and 1995 and by 1993, insolvent banks accounted for 20 percent of total assets and 22 percent of banking system deposits (Caprio and Klingebiel, 1996). Various measures were put in place to cope with the crisis which included establishment of a deposit insurance scheme, re-regulating interest rates, strengthening the regulatory powers of the CBN and legislations enhancing the speedy trial of erring banking officials. In this paper we conduct an empirical evaluation of the effects of financial liberalisation on financial fragility in Nigeria. Financial liberalisation has been recognised as a key factor responsible for financial fragility and banking crises (Diaz - Alejandro, 1985; Demirguc - Kunt and Detragiache, 1999; Kaminsky and