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THE IMPACT OF FOREIGN DIRECT INVESTMENT ON THE NIGERIAN BANKING SECTOR

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CHAPTER ONE

                             INTRODUCTION

  • BACKGROUND TO THE STUDY

Foreign direct investment is viewed as a major stimulus to economic growth in developing countries. Its ability to deal with two major obstacles, namely, shortages of financial resources and technology and skills, has made it the centre of attention for policy-makers in low-income countries in particular. Only a few of these countries have been successful in attracting significant FDI flows however. From the early 1970’s net resource flows to developing countries have followed an uneven path, but have risen rapidly since 1986 to an unprecedented U.S $285 billion in 1996(World Bank,1996).The fluctuating nature of private capital flows has played a key role in this. Whereas official flows have continued broadly unchanged after a peak in 1989-91 private capital flows have experienced two waves of explosive growth, the first from 1975 to 1981, dominated by bank lending involving a high proportion of recycled petrol-dollars, the second since 1990,dominated by foreign direct investment.

In the 1970s FDI made up only 12% of all financial flows to developing countries (World Bank, 1996). Between 1981 and 1984 there was a sharp fall in private lending as international banks lost confidence in borrowing countries financial stability following the debt crisis of 1982. Since the mid 1980’s the growing integration of markets and financial institutions, increased economic liberalization, and rapid innovation in financial instruments and technologies, especially in terms of computing and telecommunications have contributed to a near doubling of private flows. Most significant has been the steady progression of FDI to a 35% share in 1990- 1996(World Bank, 1996). An examination of net private capital flows by income group reveals the fluctuating nature of those to middle-income countries which were severely affected by the debt crisis of 1982 and to a lesser extent by the 1994 Mexican crisis. Low income countries, on the other hand have seen a smoother rise in inflows of private capital. Most of them were less affected by the debt crisis, because of their low level of commercial bank loans, due, in part, to their previously closed economies and their lack of suitable financial markets. It was only towards the end of the 1970s that those in Asia in particular began to open their doors wider for foreign capital.

According to the World Bank, Nigeria is the second largest foreign direct investment recipient in Africa (World Bank, 1996). Traditionally FDI had been concentrated in the extractive industries, but there has been a recent diversification into the manufacturing, services (banking sector) and other sectors respectively. The regulatory frame-work for the promotion of foreign direct investment received a boost in Nigeria with the enactment of the Nigerian Investment Promotion Commission Act and the Foreign Exchange (Monitoring and Miscellaneous Provisions) Act all in 1995. A look at the trend of FDI in Nigeria since 1961 has shown that the economy has lagged in FDI inflows. Sectoral composition of FDI inflows into Nigeria lacks production oriented investment that could help integrate the economy into international production chains. On the aggregate, at N10371.5 and N2555.9million the naira equivalent of FDI inflows and outflows respectively was the highest for 40years (see table 6). It is equally interesting to know that the overvaluation of naira equally accounted for the seemingly heaviest net inflows of FDI into Nigeria in 1982 when the exchange rate was U.S$1.49 to N1 and the consequent FDI activities resulted in $2,414.8million. That is, with only N1, 624.9million, the recorded net flow in dollar terms was $ 2,414.8million. The huge net inflow was due to substantial unmerited profit from United Kingdom (UK) companies operating in Nigeria as well as due to other foreign liabilities which TNC’s affiliates operating in Nigeria from UK and USA were to pay as overseas commitments, but inadequate foreign exchange made such accrued payment impossible. A further analysis of the flows revealed that for two consecutive years (i.e. 1989 and 1990 activities of foreign investors, on the whole, resulted in Nigeria becoming a net exporter of capital resources (i.e. making more outflows than inflows) to the tune of $59.4 and $57.8 million respectively. Regional analysis of the flows has shown that American foreign investors were the most inconsistent in Nigerian economy. During the 40 years, they recorded 15 years of net outflow of net capital flows beginning from 1975. Both UK and Western European foreign investors recorded 4 years of net outflow of FDI each. Investors from other unspecified countries appeared most consistent as their inflow of capital always exceeded their outflows (except for three years i.e. civil war year of 1967, 1985 and the 1993).

The unprecedented explosion in the Nigerian banking industry during the late 1980s attested to how the performance of the operators in a sector can attract foreign investors. The launch of the Structural Adjustment Programme (SAP) in July 1986 opened the flood gate of applications for banking licenses both by foreign and domestic investors. There was a phenomenal increase in the number of registered banks in operation due to perceived high level of illegal arbitrage profits made from trading in foreign exchange. Between 1985 and 1992, for instance, the number of licensed commercial and merchant banks in the country increased from 40 to 120 (Uche/Osho, 1997). There was therefore massive influx of foreign investors into the banking sector during this period. The Nigerian banking sector propelled by the 2005 consolidation, is today steadily positioning itself as the key driver for the Nigerian economy. Though the challenges brought about by the global economic recession have created a lot of setback for the sector, it has remained consistent in growth. Recently, the financial times described it as the fastest growing sector of the Nigerian economy. Operating at the short term end, the sector was rated by Fitch Corporate (Fitch) as recording the highest credit growth among countries covered by Fitch during 2007/2008. For the banking sector to fully maximize its potential of driving Nigeria’s economic resurgence, and ultimately becoming a regional financial centre, experts say that there necessarily has to be an infusion of foreign players and capital from across borders. The entrance of foreign investors will benefit the country by providing deeper liquidity to the market with the resultant reduction in the cost of capital. This would in turn impact on production, employment and living standards. Given the competition amongst countries for foreign direct investment, Nigeria (especially the Nigerian banking sector) has the challenge of persuading astute investors to impact capital in Nigeria.  The recent global economic meltdown has however raised a lot of concern to economic analysts and development experts. Following the unprecedented level of capital flight that occurred during the last credit crunch, the challenge is whether foreign direct investment is a worthwhile activity at all.

  • STATEMENT OF THE PROBLEM

In spite of the laudable benefits the Nigerian banking sector stands to derive from the inflow of foreign capital (FDI) and its attending contribution to economic growth, improvement of the living standard of the people and the provision of social amenities, the problem arises as to what extent the Nigerian banking sector and indeed the entire economy should depend on foreign direct investment.

The credit crunch which dealt a total blow to banks in the United States (US), Europe and Asia also came to roost in Nigeria. It is no longer a secret today that the Nigerian financial system most particularly the banking sector, is experiencing a liquidity crisis which has made banks to mop up any available funds to fortify themselves and avoid lending to one another. The phenomenon is believed by analyst to be a back lash from the severe credit crunch that plagued international financial institutions. In recent years, hedge funds and private equity firms from Asia, the US and Europe invested heavily in equities and bond markets in Nigeria. But as institutional investors around the world battled to provide cushion for their credit markets which was thrown into unprecedented deficit as a result of the credit crunch, they had to pull out their funds from Nigeria. From 2006 and 2007, foreign direct investment (FDI) in Nigeria stood at $26.5 billion according to estimates of the United Nations Conference on Trade and Development. In 2007 alone, the front line banks were said to have raised more than $10 billion in capital to increase their capacity to lend (Salif, 2008). The bulk of these funds have been withdrawn by their owners. Financial analyst say the implication of this capital flight is that the economy may take a much longer time to recover because the FDI’s will not return immediately even when the dust might have settled. A similar scenario played itself out with the indigenization policy of the 1980’s when foreign investors were driven away and it took a long time to bring some of them back.

Worried by the level of unprecedented capital flight that occurred during the last credit crunch, the researcher in this work examined and studied the extent to which foreign direct investment (FDI) could impact on or affect an economy. The challenge of most developing economies today (Nigeria inclusive) is their overdependence on foreign capital which do not bring positive impacts only but negative impacts as well. This work has therefore, tried to look at the extent to which such impact is; or should be, on the Nigerian banking sector, with a view to proffering possible recommendations.

  • RESEARCH OBJECTIVES

         The objectives of the study are as follows:

(1)   To ascertain the total amount of cumulative FDI capital inflow that has come into the Nigerian banking sector from the year        2006 to 2010.

(2)   To ascertain the level of impact foreign direct investment has on  the liquidity position of the Nigerian banking sector.

(3)   To determine the level of impact foreign direct investment has on  total asset size of the Nigerian banking sector.

(4)   Ascertain whether it is advisable for the Nigerian banking sector  to depend largely on foreigners for management efficiency or not.

(5)   To determine the level of impact foreign direct investment has on  the contribution of the Nigerian banking sector to gross           domestic product.

 

1.4        RESEARCH QUESTIONS

Our research questions are:

  • What level of impact does foreign direct investment have on the capital base of the Nigerian banking sector?
  • What impact does foreign direct investment have on liquidity position of Nigerian banks?
  • What is the impact of foreign direct investment on the total asset size of the Nigerian banking sector?
  • To what extent does foreign direct investment contribute to           management efficiency of the Nigerian banking sector?
  • What level of impact does foreign direct investment have on the contribution of the Nigerian banking sector to gross domestic product?

 

 

 

 

  1.5    HYPOTHESES OF THE STUDY

The hypotheses of our study are:

(1)  Ho Foreign direct investment does not have a significant positive  impact on the capital base of the Nigerian banking sector.

(2)  Ho Foreign direct investment does not have a significant positive  impact on liquidity position of the Nigerian banking sector.

(3)  Ho Foreign direct investment does not have a significant positive   impact on total asset size of the Nigerian banking sector.

(4) Ho Foreign direct investment does not have a significant positive   impact on management efficiency of the Nigerian banking sector.

(5) Ho Foreign direct investment does not have a significant positive    impact on the contribution of the Nigerian banking sector to     gross domestic product.

 

 1.6    SCOPE OF THE STUDY

The emphasis of this study is on twenty five (25) deposit money banks. The period 2006-2010 covers the aspect dealing with our data for statistical analysis. The time period has been selected considering that it offers recent time series observations and it constitutes a period of structural changes for the Nigerian banking sector. The banking sector reforms which focused on strengthening and consolidating the system took place within this period. The major emphasis of the reforms on recapitalization and proactive regulation has structurally changed and positioned the industry to perform its role of intermediation and economic development. At the end of the exercise, twenty five (25) banks emerged out of the eighty-nine (89) banks that existed before the exercise began. The successful banks accounted for 93.5 per cent of the total deposit liabilities of the banking system while N406.4 billion was raised by banks from the capital market. Aggregate capital base of the sector rose from about US$3.0 billion to US$5.9 billion. The program also attracted N350.2 (about US$3.0 billion) in new investments and $500.0 million from foreign direct investment (FDI) inflow (CBN, 2007). The Central Bank of Nigeria (CBN) announced the cancellation of universal banking system within the same period.

 

1.7   SIGNIFICANCE OF THE STUDY

The research study is significant in two major ways-practical and academic.

  • Practical Significance:

(i)This research will enable policy makers and regulators develop policies and regulations that will ensure effective administration and management of foreign investment in Nigeria.

(ii)It will assist investors who have interest in the banking sector know exactly the issues on ground.

(iii)To bankers the research will help them know whether to do more to attract investors into the sector or not.

(iv)Specifically, to bankers it will expose to a large extent the goings-on in the banking sector with regard to relevant variables and a comparative analysis of their actions over some years.

(v)To the Nigerian Investment Promotion Commission, the research will help them have a clear cut understanding of what is obtainable in the banking sector with respect to foreign direct investment so as to take informed decisions.

 (b)   Academic Significance:

In the academic arena, the study will prove to be significant in the following ways:

(i)It will contribute to the enrichment of literature on foreign investment in the banking sector.

(ii)The research will serve as a body of reserved knowledge to be referred to by researchers.

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