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                                                           CHAPTER ONE


1.1 Background of the study

The lending rate and deposit rates spread has been recognised in literature as a key indicator of the performance of the financial system. It is also generally accepted as a measure of intermediation efficiency both in developed and developing countries (Akinlo and Owoyemi 2012). A large spread works as a weakness to expansion and development of financial intermediation process. In other words, it indicates the level of inefficiency of the financial system. This is because, possible savers are not encouraged as a result of low return on deposit and thus financing for possible borrowers are limited (Akinlo and Owoyemi 2012). According to Kama (2009), the real economy is benefited by financial system that are more efficient by allowing expected returns that are high for savers or lowering lenders costs such that investment rises and the economy grows. Globally, it is recognized that efficiency in intermediation process establishes a smooth mechanism for the mobilization of funds from the surplus sector and the transfer of these funds to the deficit sector of the economy for investment purposes (Nwachukwu, 2011). This is in  line with Kendall (2000), who argued that mobilized resources (i.e., savings) provides developed and developing countries (including Nigeria) with the much needed capital for investment in productive activities which will lead to reduction in external borrowing of government, employment creation and increase the people’s standard of living. In the light of the above explanations, different countries have adopted different interest rate regimes to improve the efficiency of the intermediation process (i.e., minimize the gap between lending and deposit rates). In Nigeria for example, various regimes such as control deregulation, regulation and complete deregulation have been experimented at different periods, since the introduction of the Structural Adjustment Programme (SAP) in 1986. Prior to the deregulation of interest rates completion in Nigeria, the financial sector worked under the regulations of finance and rate of interest were said to be blocked. The resulting low interest (deposit) rates during this regime discouraged mobilization of savings and through financial system; the directing of savings was mobilized. As a result, the Nigerian government took steps to loosen interest rates (i.e., lending and deposit rates) as part of the reform of the entire financial system (CBN, 2007). The deregulation of the rate of interest was as a result of the financial sector reforms, which took effect from August 1987 (Ikhinde, Obute and Adyorough 2012). The interest rate regime was liberalized by the Central Bank of Nigeria (CBN) and employed the policy of fixing only its minimum rediscount rate to indicate the anticipated direction of interest rate., the policy was improved in 1989 when the CBN issued further directives on the required spreads between deposit and lending rates. During this period, the deposit rate was 18.2% and the lending rate was 25%.In 1991, the government prescribed a maximum margin between each bank’s average cost of funds and its maximum lending rates. Later, the maximum lending rate and the deposit rate of 14% and 20% and a respectively was prescribed by the CBN. A fractional of the deregulation was, however, restored in 1992 when financial institutions were required to only maintain a specified spread between their average cost of fund and maximum lending rate. The deposit and lending rates in this period were 16% and 32% respectively (CBN, 2010). Trends on various interest rate regimes, lending and deposit rates and savings as percentage of GDP are shown with the aid of table below:

Table 1: Average lending and deposit rates across various regimes


Pre SAP Period


SAP Period (Deregulated period)


SAP Period

(Regulated Period)


Lending Rate





Deposit Rate





Interest Rate Spread (%)




Private Savings (% of GDP)




Public Savings (% of GDP)




National Savings (% of GDP)





(% of GDP)




Private Consumption (% of GDP)




Source: Statistical Bulletin of Central Bank of Nigeria (2010)

 From the above table, it shows that average lending and deposit rates in 1981-1985 were 7.8% and 4.7% respectively. This corresponds to an average spread of 3.1% in the pre- SAP period. During the SAP period (Deregulation period), average lending and deposit rates rose to 20.3% and 15.7% respectively. This resulted to high average interest rate spread of4.6%. Interestingly, the spread during the SAP period (Deregulation period) was higher than the spread in the pre-SAP period (i.e., in 1970-1985). This implies that the deregulation exercise in the SAP period (Deregulation period), which was meant to reduce the gap in interest rate failed to achieve the intended objective. In the SAP period (Deregulation period), the private, public and national savings were 27.2%, 21.5% and 19.7% of the GDP respectively. These rates were higher than that of the private, public and national savings in the regulated period (i.e., in 1970-1985). This could be attributed to the rise in deposit rate during the SAP period as shown in the table above. The table also shows that in 1994-2005which was the SAP period (Regulation period), average lending rate rose to 20.4% from 20.3% while the deposit rate reduced to 12.7% from 15.7% during the same period. This corresponds to high average spread of 7.7% compared to the spread during the SAP period (Deregulation period). This can be attributed to the re-imposed control of interest rates by the government. Furthermore, the savings rate in 1994-2005reduced to 17.4%, 13.0% and 5.6% from 27.2%, 21.5% and 19.7 during the SAP period for the private, public and national savings respectively. This can be attributed to the reduction in deposit rate from 15.7% during the SAP (Deregulation period), period to 12.7% in 1994-2005 (Regulation period), as shown on the table above. Also the average investment and private consumption in the pre-SAP period were 24.5% and 61.27% respectively, due to the increase of the interest rate spread in the SAP (deregulated and regulated) period, investment falls to 13.07% in SAP (deregulated) and 7.83% in SAP (regulated) while private consumption increase to 65.92% in SAP (deregulated) and 72.90% in SAP (regulated). The key macroeconomic variables that determine aggregate output such as savings and investment and total consumption seems to be an output determining variable that has attracted a lot of attentions and studies (Ezeji and Ajudua, 2015).This is so because about two-thirds of aggregate expenditure was account for as consumption expenditure in virtually all economies (Branson, 1989).Thus, the level of consumption per individual is seen as a central measure of an economy’s productive success. According to Mudit and Shamika (2009), one of the most relevant issues that is related to inter-temporal substitution is whether bring down interest rate paid on deposits will encourage consumers to increase consumption. This therefore suggests that the higher the spread, the higher will be the consumption expenditure. Therefore, a comprehensive study of its determinants such as the savings rate could help an economy achieve stability, increase in aggregate income and high level of employment of factors of production. (Ezeji and Ajudua, 2015). Thus, from the rate of interest regime that is unstable in Nigeria, the interest rate keeps changing such frequent changes could affect savings, investment and private consumption expenditures, which in sequence could impact on the general economy of the country (Ogunbiyi and Ihejirika, 2014). The foregoing however forms the basis of this study.

1.2 Statement of the Problem

Notwithstanding the huge financial sector reform programmes in the developing world been implemented, financial systems in developing countries (including Nigeria) typically show persistent gap in interest rate. This serves as a major constraint to savings and investment which in turn discourages economic growth and development. According to Obute et al (2012), interest rate deregulation in Nigeria was meant to encourage savings and investment by reducing the divergence in interest rate but this objective has not been achieved, since the difference between deposit and lending rates is still wide. The diagram below shows the degree of interest rate deviation in Nigeria from 1970q1 to 2010q1.

 Movements in deposit and lending interest rates from 1970q1 to 2010q4

Figure 1.1

Source: Researcher’s computation based on data from Central Bank of Nigeria Statistical Bulletin (2010)

Interest rate spread from 1970q1 to 2010q4

Fig 1.2

Source: Researcher’s computation based on data from Central Bank of Nigeria Statistical Bulletin (2010)

The diagram above shows that the spread between deposit and lending rates has been rising and falling throughout the sample period. The spread in interest rate was high between 1970q1 and 1982q4 but fell in 1983q1-1988q4. This reduction can be attributed to the removal of interest rate control in 1986-1993. The gap in interest rate gradually rose again from the first quarter of 1989 to the last quarter of 1993, even though the deregulation program was still on within this period. The spread in interest rate grew much bigger between 1994q1 and 1996q4 following government re-imposed control of interest. It continued to rise in the subsequent periods until the first quarter of 2010 despite the regulation period. The trend of the interest rate spreads is shown in Fig 1.2. It shows that the interest rate spreads from 1970 to 1985 falls from 4.00 to 0.32 which was the pre- SAP period. From 1986 to 1993 which was also the period of SAP (Deregulation), the spread of interest rate rose from 0.72 to 8.31 and from 1994 to 2005 which denote the period of SAP (Regulation), the interest rate spread also rises from 7.39 to 7.42. In 2010 it increased more to 11.6. Interest rate developments in the Nigerian economy indicates that the problem of high borrowing rates, against the backdrop of declining deposit rates poses a key challenge to financial intermediation. The persistence of this problem had been observed by the Monetary Policy Committee in several communiques, particularly following the onset of the global financial crises of 2007/08, borrowing rates have remained positive in real terms hovering around 23 -26% while savings rates have largely remained negative in real terms. The average savings rate between 2009 and 2014 was 2.13%. Savings rate, however, marginally increased following the increase in Cash Reserve Ratio on public sector deposits in the third quarter of 2013. The tight monetary policy forced banks to offer remunerative rates to mobilize private sector deposits. Notwithstanding, the emerging picture shows persistently high borrowing rates, declining deposit rates, and the widening of the interest rate spread. This clearly indicates inefficiencies in the intermediation process and instability in the financial system, which constrains savings and investment in Nigeria (Tule, Audu, Oji, Oboh, Iman and Ajayi 2015) Financial instability in developing countries like Nigeria has been associated with serious issues in the financial sector. These issues have been relatively large in terms of weak public confidence in financial markets and inefficient financial intermediation, posing great threat to savings and investment (Kama, 2009). Instability of financial system could be damaging to the economy, through a wide gap in interest rate. Furthermore, there are various developmental finance schemes that have been introduced by CBN to specifically address problems of high rate of lending and access to credit in Nigeria. These measures include: Agricultural Credit Guarantee Scheme Fund (ACGS) in 1978, Interest rate drawback programme in 2002, the Commercial Agricultural Credit Scheme (CACS), Small and Medium enterprises Equity Investment Scheme (SMEIS) in 2001, and Microfinance policy in 2004. In 2010, the Central Bank, injected N500 billion into the economy as a special intervention fund under a quantitative easing program to ensure the flow of liquidity to the real economy at reasonable interest rates. These measures were complemented by interventions to manage interbank liquidity and the use of treasury securities (Tule et al, 2015). Studies such as Newman (2012); Umejiaku (2011); Tule et al (2015) and Jibrina, Iyaji and Ejura (2014) have argued that despite the policy measures put in place, the phenomenon of high lending rates still persists as reflected in the complaints of manufacturers, industrialists, and Small and Medium-sized Enterprises (SME) operators who consistently identify high lending rates as a key contributor to the unfavourable business and investment climate in Nigeria. A strong financial system with less spread in interest rate is still not in place, as most people still do not have access to commercial bank credits. From the point of view of those who seem to fully use the services of the financial sector are not finding it so easy. The result of incompetence in the system of banking together with continued limitation of success that may have been recorded caused by corruption. According to Kama (2009), the banking system still leaves out certain people who should have been benefiting from the interaction created by the bridging of financial gap between lenders and borrowers of credit in the economy. This is indicative of inefficiency and poor performance of the financial system. Financial sector intermediation inefficiency which could result from banking crisis, not only pose a barrier to savings and investment but also to consumption expenditure. This is because, it limits the amount of credit that goes to households for the purchase of durable goods (Damar, Gropp and Mordel 2014). For instance, the global financial crisis of 2007 and 2008 which spread towards developing countries and more particularly in Nigeria, negatively affected household consumption expenditures. This is reflected in available statistics from CBN (2010) which shows a sharp downward trend in private consumption spending. For instance, there was a drastic fall in private consumption expenditure as a percentage of total expenditure from 102.8% in 2003 to 58.5% in 2006. This continuously fell to 38.3% and 31.7% in the year 2008 and 2010 respectively.  The Central Bank of Nigeria has also adopted various measures aimed at solving the problems of bank inefficiency, financial sector crisis and to boost the performance of the banking system in terms of increase in savings mobilization. Some of these measures are issuance of prudential guidelines for proper coordination of banks, regular assessment of the banks’ books and supervision of other banking operations (CBN, 2009). Studies of various kind have been done on the effects of interest rate on definite areas. These studies among others include; Udonsah (2012), Okeke (2005), Olowolaju (2008), Ekwem (2012), Udeh and Nwachuku (2016) and Acha (2011), who studied the effect of interest rates on investment and economic growth. Studies like Nwachukwu (2009), Ajakaye and Odusola (1995), Sayinbola, Sobande, and Adedeji (2012), Douglas (1996), Sakaria and Nyambe (2015), and Adeyemi and Alege (2013) have exploited interest rate relationship with savings, interest rate and consumption expenditure both in Nigeria and outside Nigeria. However, no existing study to the best of our knowledge has dealt with the effect of interest rate spread on savings, investment and private or household consumption. From the above studies, this study thus pursues to fill this knowledge gap that currently exists and discover how interest rate spread affects savings, investment and private consumption in Nigeria.

1.3 Research Questions

1. How has interest rate spread impacted savings in Nigeria?

2. What is the impact of interest rate spread on investment in Nigeria?

3. What is the effect of interest rate spread on private consumption expenditure in Nigeria? 

1.4 Research Objectives

The general objective is to investigate the impact of interest rate spread on savings, investment, and private consumption in Nigeria.

Specific objective are as follows

(i).To ascertain the impact of interest rate spread on savings in Nigeria

(ii). To investigate the impact of interest rate spread on investment in Nigeria

(iii). To ascertain the effect of interest rate spread on private consumption expenditure in Nigeria

1.5 Research Hypotheses

H01: Interest rate spread does not significantly impact on savings in Nigeria.

H02: Interest rate spread does not significantly impact on investment in Nigeria.

H03: Interest rate spread does not significantly impact on private consumption expenditure in Nigeria.

1.6 Significance of the Study

This study investigates the current position of interest rate spread on investment, savings and private consumption. This research work will be of immense help to the Federal Government of Nigeria through the Central Bank of Nigeria on the need to introduce an interest rate regime that will help to reduce the wide spread in interest rate in Nigeria with the aim of achieving social optimum resource allocation; engendering a systematic development of the financial sector; curbing inflation and reducing the burden of internal debt serving by government and Deregulated Regime under the Structural Adjustment Program (SAP). The deregulation interest rate allowed banks to determine their deposit and lending rates according to market conditions through negotiations with their customers. It will provide information to the government on the need for the provision of enabling environment which will help to boost the level of savings and investment in Nigeria. This investigation will also serve as a stepping stones for researchers who develop interest in carrying out empirical analysis on the concept of interest rate spread on investment, saving and private consumption in Nigeria. Finally, student will find this piece highly relevant as it will undeniably increase their knowledge and horizon on the concept of interest rate spread and its impact on investment, savings and private consumption. The education sector is also considered as one of the significant beneficiaries because it is believed that this research will serve as a reference point to future researchers in this subject matter. Above all, it will add to existing stock of knowledge, thereby filling up the knowledge gap.

1.7   Scope of the study

This study is focused on the effect of interest rate spread on savings, investment and private consumption expenditure in Nigeria. The study is principally limited to the analysis of the Nigerian economy. In measuring interest rate spread, savings, investment, and private consumption expenditure in Nigeria. The data to be used for analysis are time series data ranging from 1981 to 2015. The data would be sourced from the Central Bank of Nigeria Statistical Bulletin, (2015). The choice of the period length is based on data availability.

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