THE RELATIONSHIP BETWEEN STOCK PRICES AND COMMERCIAL BANKS LENDING RATES IN NIGERIA

THE RELATIONSHIP BETWEEN STOCK PRICES AND COMMERCIAL BANKS LENDING RATES IN NIGERIA

1.0 REVIEW OF RELATED LITERATURE
In Nigeria, two broad monetary policy regimes could be distinguished since the establishment of the Central Bank in 1959. The first regime was characterized
by direct administrative controls on credit and interest rates, while the other dwells on the era where credit to the private sector was competitively
distributed. In the first period (until 1986) banks were assigned mandatory guidelines on how much credit to make to preferred sectors of the economy. More
so, minimum cash ratios were stipulated and special deposits were used to control free reserves with banks. Thus, banks made most loans essentially in
order to meet government regulations and not necessarily based on the expected returns. The wisdom of this era was to stimulate growth of the domestic
economy by delivering credit at low interest rates, while pegging and defending the naira from wanton depreciation, mainly motivated by the need to avoid
foreign inflation in imported intermediate and capital goods. According to Nnanna (2001) historically, the Central Bank of Nigeria via its monetary policy
circulars had directly controlled the volume and cost of credit in the economy, until the era of financial sector liberalization in the mid-80s. He also found in
the same study that distortions in the pricing of loans caused by the administrative intervention in the market rendered financial intermediation by the
deposit money banks ineffective. In the era of liberalized interest rates beginning from 1993, deposit money banks engaged in diligent credit packaging and
risk analysis before making loans in order to reduce carrying non-performing assets in their books. Consequently, loans were advanced based on the
computed returns to investment and the relative risk in the borrowing sector. The major consequences of liberalization have been increases in the volatility of
interest rates and increased sensitivity of the exchange rate to domestic economic developments and external shocks, which eventually affected prices and
consequently, increased the sensitivity of exchange rate to the interest rate as stable exchange rate helped lock-in inflation. From 1970 to 1985 (Figure 1),
which marked the period of strict administrative controls, the standard deviation of the prime lending rate was 1.8 and rose to 6.8 in the period between 1986
and 1992. During this period the economy had become liberalized to a large extent, but interest rate liberalization only came in 1993. However, the extent of
dispersion of interest rate slowed to 5.3% in the years since 1993. The wide dispersion in the years are direct controls is indicative of the elects of market interactions and administrative frictions in the policy break point, while the relative convergence are 1993 could be explained by the numerous entries in the banking industry and improved efficiency
of the intermediation process. Nnanna and Dogo (1998) have shown that financial liberalization has led to increased credit to the private sector of the economy

THE RELATIONSHIP BETWEEN STOCK PRICES AND COMMERCIAL BANKS LENDING RATES IN NIGERIA