INTEREST RATE PASS THROUGH IN NIGERIA: 2007

INTEREST RATE PASS THROUGH IN NIGERIA: 2007

Abstract The study sets out to determine the magnitude and speed of interest rate pass through in Nigeria using a monthly data for the period 2007:1 to 2011:1. The aim was to uncover the extent to which changes in policy rate pass through to market and retail rates and also from market rate to retail rate. Auto Distributed Lag (ARDL) approach otherwise known as the Bounds testing approach was employed because of its inherent advantage (allowing for testing both I(0) and I(1) at the same time. The major findings are: First, interest rate pass through is incomplete in Nigeria both in the long and short run, which is consistent with the generality of the empirical literature. Secondly, the pass through is more substantial in the long run than in the short run in all stages of the pass through. Thirdly, the pass through is greater from MPR to market rate than from money market to retail rate. Finally, a substantial long run pass through is found between MPR and prime lending rate, there was none between MPR and deposit rate. We concluded that interest rate is a potential monetary policy tool in Nigeria especially from policy rate to market rate, which is eventually transmitted to real sector. We recommend that efforts should be made towards improving the pass through of policy rate to retail rate. vii

TABLE OF CONTENTS

COVER PAGE ………………………………………………………………………………………………………………………. i DECLARATION ………………………………………………………………………………………………………………….. ii CERTIFICATION ………………………………………………………………………………………………………………… iii DEDICATION …………………………………………………………………………………………………………………….. iv ACKNOWLEDGEMENT ……………………………………………………………………………………………………….. v Abstract…………………………………………………………………………………………………….vi TABLE OF CONTENTS……………………………………………………………………………………………………….. vii LIST OF TABLES ……………………………………………………………………………………………………………….. ix LIST OF FIGURES ……………………………………………………………………………………………………………….. x CHAPTER ONE …………………………………………………………………………………………………………………… 1 Introduction ………………………………………………………………………………………………………………………….. 1 1.0 Background ………………………………………………………………………………………………………………. 1 1.1 Statement of problem …………………………………………………………………………………………………… 2 1.2 Research Questions ……………………………………………………………………………………………………… 3 1.3 Objectives of the Study ………………………………………………………………………………………………… 4 1.4 Justification of the Study ………………………………………………………………………………………………. 4 1.5 Scope of the Study ………………………………………………………………………………………………………. 5 1.6 Limitation of the Study ………………………………………………………………………………………………… 5 CHAPTER TWO ………………………………………………………………………………………………………………….. 6 Literature Review ………………………………………………………………………………………………………………….. 6 2.0 Introduction ………………………………………………………………………………………………………………. 6 2.1 Channels of Monetary Policy Transmission ……………………………………………………………………… 6 2.1.1 Definition of key terms ………………………………………………………………………………………………… 9 2.2 Interest Rate Adjustment-conceptual definition ………………………………………………………………. 10 2.3 Factors Affecting the Adjustment of Interest Rate …………………………………………………………… 11 2.4 Empirical Literature Review ……………………………………………………………………………………….. 14 2.5 Overview of Monetary Policy and Financial Reforms in Nigeria ……………………………………….. 17 2.5.1 Pre-Financial Liberalization Era: 1970-1985 ………………………………………………………………….. 18 2.5.2 Monetary Policy before SAP ……………………………………………………………………………………….. 20 2.5.3 Financial Liberalization Era: 1986 – 2006 ………………………………………………………………………. 22 2.5.3.1 Changes in Structure ………………………………………………………………………………………………….. 22 2.5.3.2 Summary Indicators …………………………………………………………………………………………………… 24 viii 2.6 Interest rate management in Nigeria ……………………………………………………………………………… 27 2.6.1 Management prior to 1986 …………………………………………………………………………………………..

INTEREST RATE PASS THROUGH IN NIGERIA: 2007