Impact of Interest Rate on Nigeria Saving



1.1.      Background to the study

The Financial system has long been recognized to play an important role in economic development. The benefit derivable from a healthy and developed financial system relates to savings mobilization and efficient financial intermediation roles. In terms of financial intermediation between savers (lenders) and borrower such benefits include; spreading risk, reduction of transaction and search costs. Financial institutions create liquidity in the economy by borrowing short-term and lending long-term. These financial intermediaries bring the benefit of asset diversification to the economy. They mobilize savings from atomized individuals for investment thereby solving the problem of indivisibility in financial transactions. Consequently, mobilized savings are invested in the most productive ventures irrespective of the source. The extent to which this could be done depends on the level of development in the financial sector as well as the savings habit of the populace. Based on these expectations, Nigeria has implemented financial liberalization under different financial structures and macroeconomic conditions. The availability of investible funds is therefore regarded as a necessary starting point for all investments in the economy which will eventually translate into economic growth and development (Uremadu, 2006, cited in Olayemi & Michael, 2013).

Mckinnon and Shaw (1973 cited in Onwumere, et al, 2012), attributed financial repression as the cause of the unsatisfactory growth performance of developing countries. They argued further that financial repression arises mostly when a country imposes ceilings on nominal deposit and lending interest rate at a low level relative to inflation.

Savings represent that part or portion of disposable income not spent on current consumption. It comprises of time deposits in the bank and the various forms of equities. According to the Keynesian economics, savings is the amount left over when the cost of a person’s consumer expenditure is subtracted from the amount of disposable income that he or she earns in a given period of time.

The Institution in the financial sector like the deposit money banks (DMBs) or commercial banks mobilize savings deposit on which they pay certain interest. An Interest rate is an important economic price, this is because of its diverse role in the economy, whether seen from the point of view of cost of capital or from the perspective of opportunity cost of funds, it has a fundamental implication for the economy.

Interest rate on savings account are part of what makes funds available in the bank rather than at home more reasonable. If one saves money in the bank account, it normally earns some form of benefits depending on how long the money is saved in the bank. Those direct benefits or returns which the money earns while it was in the bank account are referred to as interest rate.  Interest rate is regarded as the payment for use of capital or money. Keynes regarded interest rate as a purely monetary phenomenon, payment for the use of money. It is the reward for parting with the liquidity of money. Thus it is a premium which is offered to wealth holders to induce them to part with their cash. When people abstain from consumption they save and interest rate becomes the reward for saving. Conceptually, interest rate can be seen as the reward for saving.

Interest rate increase savings when cost of capital and availability of credit are influenced, if interest rate is administratively determined it is known as fixed interest rate and floating if determined by market forces. To effectively mobilize savings in an economy, the deposit rate (interest rate) must be relatively high and inflation rate stabilized to ensure a high positive real interest rate which motivates investors to save from their disposable income. In Nigeria, the problem of mobilizing savings has been the bane of economic growth and development.

Since the oil shock in Nigeria and in the early 1990’s savings mobilization has been declining (chete, 1999 in Olayemi & Michael, 2013).  However this trend conceals a large and increasing dispersion of saving rate, particularly among developing countries. The large heterogeneity in savings behaviour is associated to country and time differences in levels of development, growth performance, and fiscal & financial policies.

The interest rate reform policy under financial sector liberalization was needed to remedy the problems caused by the financial repressive policies. Since the introduction of financial liberalization concept in the 1970s, many countries such as Angola, Burundi, Congo, Cote d’lvoire, Gambia, Chana, Kenya, Madagascar, Malawi, Mozambique, Nigeria, Rwanda, Tanzania, Zambia, Zimbabwe, India, China, Turkey, etc. have made attempts at liberalizing their  financial sectors by deregulating interest rates, eliminating or reducing credit controls, allowing free entry into the banking sectors, giving autonomy to commercial banks, permitting private ownership of banks and liberalizing international capital flows. Odhiambo (2009) posits that of these six dimensions of financial liberalization, interest rate liberalization seems to have been the main centre of attention. In Nigeria, financial sector reforms began with the deregulation of interest rate in august 1987 (Olayemi & Micheal, 2013). Prior to this period, in the early 1980s the financial system operated under financial regulation and interest rates were said to be repressed (fixed) by the central bank of Nigeria (CBN) on the basis of policy decisions. The major objectives during this period were; to obtain optimum resources allocation to promote orderly growth in the financial market and facilitate flow of credit to the preferred sectors- agriculture, manufacturing etc, (Soludo, 2008). During the era of fixed interest rates, real interest rates were generally negative. It lead to financial disintermediation, leading to low level of savings, and resulting to low level of  direct investment & low level of growth. Funds were inadequate as there was a general lull in the economy, monetary and credit aggregates moved rather sluggishly. Consequently, there was a persistent pressure on the financial sector, which in turn necessitated a liberalization of the financial system. The resulting low or negative interest rate caused by financial repression discouraged savings mobilization and channelling of the mobilized savings through the financial system. This has a negative impact on the quantity and quality of investment and hence economic growth. Therefore, the expectation of interest rate reform was that it would encourage savings and make loanable funds available to the banking institutions.

However, in a dramatic policy reversal, the government in January, 1994 out-rightly introduced some measures of regulation into interest rate management. It was claimed that there were ‘wide variations and unnecessarily high interest rates’ under the complete deregulation of interest rates (CBN, 2010). Banks were allowed to determine deposit and lending rate according to market forces through negotiations with their customers (Soludo, 2008; Nwachukwu & Odigie, 2009). Interest rate rose following the deregulation of the financial sector (Soludo, 2008). What is unclear however is whether there is a strong response in savings as a result of the rising interest rate? These among others spur the interest of the researcher in the relationship that exists between interest rate & saving in Nigeria.

1.2       Statement to the Problem

Over two decades ago, Nigerian economy witnessed the introduction of Structural Adjustment Program (SAP) which shifted emphasis from public sector to private sector. The goal was to, among other things, encourage private domestic savings, private domestic investment and capital formation in order to enhance economic growth and development, but unfortunately, the level of funds mobilization by banks through the use of interest rate is quite low or has not been very effective due to a number of reasons; according to Nnanna, et al (2004) is the attitude of banks towards small savers.  The major function of interest rate in Nigeria and indeed other countries of the world is to ensure a rate of interest capable of inducing savings mobilization in the economy. The use of interest rates as stimulants in savings mobilization has not been very effective in Nigeria. The argument put forwards as the cause is that financial sector is weak. For this reason, people prefer their money outside the banking system, which many believe is shallow and prone to distress. The reason why saving is not responsive to interest rates as highlighted by Acha (2011) are; lack of confidence in the banking system; low income and preference for cash.  In the same vein, Ostry and Reinhart (1995) identified the reason to; lack of sophistication in domestic financial market; proportion of the population living or near subsistence income level and liquidity constraints. The situation in Nigeria mirrors the reasons given above. There are few banks and are mostly located in urban areas and there is little scope for true market determination of interest rate. Available data has it that about 61 per cent of Nigeria lives below poverty line, earning less than 1 dollar per day. Interest rate is of no consequences to this category of people as they can barely subsist let alone save. Despite the policy measures put in place-recapitalization of commercial banks, the various poverty eradication programmes and policies, etc. a robust financial system is still not in sight as most people still do not have confidence in the banks. Besides, even those who seem to fully utilize the services of the financial sector are not finding it so easy this is because of the tedious nature of the banking process and inefficiency in the banking system coupled with inept corruption which has continued to mar success that may have been recorded. Hence, Nigeria banks have continued to toll towards distress to extent that some banks had to be rescued even.  The macro-economic policy formulation challenge confronting many developing countries today is how to achieve single digit inflation, manageable trade and balance of payments deficits and higher savings and investments rates to finance long term economic growth. This problem has become more complex in today’s world. In view of the stated research problem, the study broadly aimed at examining how to mobilize savings through real interest rate in Nigeria as a means towards achieving wider goal of economic development.

1.3       Research Questions

  • To what extent does interest rate impacted on savings in Nigeria?
  • Is there any causal relationship between interest rate and savings in Nigeria?
  • To what extent does long-run relationship exist between interest rate and savings in Nigeria?

1.4       Objectives of the study

The broad objective of the study is to empirically investigate the relationship between interest rate and savings in Nigeria. Specifically the objectives of this study include to:

  • evaluate the impact of interest rate on savings in Nigeria.
  • determine the causal relationship between interest rate and savings in Nigeria.
  • examine the long-run relationship between interest rate and savings in Nigeria.

1.5       Hypotheses of the study

  1. Ho: Interest rate has no significant impact on savings in Nigeria.
  2. Ho: Interest rate has no causal relationship with savings in Nigeria.
  • Ho: Interest rate has no long-run relationship with savings in Nigeria.


1.6       Significance of the study

In analysing the relationship existing between interest rate and savings, it will enhance our knowledge in understanding the level at which interest rate affect savings in Nigeria. The study is of great importance to policy makers, as findings base on the study will serve as a guide to making appropriate policy decisions. It is also of great importance to the government (CBN), business firms, investors, and households. The household stands to benefit from improved and robust financial system. Finally, the study will serve as an indispensable tool for students, the general public and should serve as a library resource for future researchers.

1.7       Scope and limitations of the Study

The study shall concern itself with the investigation of the relationship between interest rate and savings in Nigeria and shall cover a sample period of 1981-2015.

In the course of carrying out this study, the researcher encountered some challenges.

  1. Finance: this is the major obstacle faced by researchers, access to good and qualitative materials are readily available to the researcher but at an exorbitant cost.
  2. Internet access: due to network fluctuation & failure, researcher finds it so difficult to get access to more materials.
  3. Availability of data: most of the information used is obtained basically from the Central Bank of Nigeria (CBN) and most time it is difficult to get adequate information from the financial institutions.

In spite of the above mentioned constraint, the researcher, however put in adequate effort to ensure that the result will be relevant and also serves the intended purpose.


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