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THE IMPACT OF INTEREST RATE AND SAVINGS ON THE FINANCIAL DEVELOPMENT EVIDENCE OF SOME SELECTED WEST AFRICAN COUNTRIES.


Project topic for Economics department

                                                         CHAPTER ONE

  • Background of the Study

Financial market performance has frequently been cited in the economic literature as a key requirement for enhancing economic growth. (Bencivenga and Smith, 1991; King and Levine, 1998). The main understanding is that a well –functioning financial system contributes to growth by mobilizing savings and channelling thwm through its financial intermediaries to investors that have identified productive investment opportunities (Ndikumana, 2001; Adjasi and Biekpe, 2006) In West Africa today, banks fund mobilization is quite low as a result some reason ranging from low savings deposit rates to the poor banking habits or culture of the people. (Nnanna, Englama & Odoka, 2004) and the attitude of banks towards smaller savers. (Simon-Oke & Jolaosho, 2013). Many people find it difficult to save because it actually involves decreasing current consumption and investment in the future standard of living. People believes that savings is the remaining after their current wants and needs have been achieved. Acoording to Olusoji (2003), savings is seen as a portion of current income not spent on consumption and when it is applied to capital investment, savings increase output. Savings is also a portion of disposable income not spent on consumption of consumer goods but accumulated or invested directed in capital equipment or in paying of a home mortgage, or indirectly through purchase or securities. An interest rate is a number that describes how much interest will be paid on a savings in a bank or other financial institution. It is also seen as an annualized cost of credit or debt-capital computed as the percentage ratio of interest to the principal. Each banks determine its own interest rate on loans and savings which can rise in times of inflation, greater demand for credit tight money supply or as a result of high reserve requirement for banks. Financial development is also seen as the institution that channel resources from surplus economics unit to deficit units for investment purposes. Savings, interest rate and financial development are important economic tools which are used to raise the standard of living in a country on basis that country that save more tends to grow faster, provided that their financial system is deep, increasing savings and ensuring that they are directed to the productive investment. In general, it is accepted that financial sector development is central to economic development (Levine, 1997). For financial development to have the impact that preferred there has to be clear channels to economic development. The theoretical relationship between savings and financial development traced to the McKinnon and Shaw (1973) stated that s developed financial sector is expected to increase the savings by raising the efficiency of financial intermediation. Financial development thus involves the establishment and expansion of financial institutions, instruments and markets which supports the investment and growth process through improvements in quality, quantity and efficiency of financial intermediary services. Financial sector is expected to improve growth by enabling the efficient allocation of capital and reducing borrowing and financial constraints. Financial sector is instrumental in achieving both short and long run economic performance through its intermediating activities in transforming and channelling deposit from surplus economic units to the deficit unit. Savings has always figured prominently in both theoretical analysis and policy design in both developed and developing economies. This prominence from its assumed direct theoretical link to future economic growth and current expenditure level via its link to consumption, according to the theories on economic growth, they emphasized the role of saving as a sources of capital accumulation and hence growth. Financial sector development can help with the growth of small and medium sized enterprises (SMEs) by providing them with access to finance. SMEs are typically labour intensive and create more job that do large firms. The financial sector development goes beyond just having financial intermediaries and infrastructures in place. It entails having robust policies for regulation and supervision of all the important entities. The global financial crisis underscored the disastrous consequences of weak financial sector policies. A large body of evidence suggests that financial sector development plays a huge role in economic development. It promotes economic growth through capital accumulation and technological progress by increasing the savings rate, mobilizing pooling savings, producing information about investment, facilitating and encouraging the inflows of foreign capital, as well as optimizing the allocation of capital (World Bank, 2012) Savings could be looked at in terms of its aggregate behaviour or at a personal or household level. According to Deaton (1989), there are many good reasons which indicate the factors that determine savings behaviour in developing countries are likely to differ from that of developed countries which include the macroeconomic and microeconomic aspect of savings. Recent economic advancement by development countries in Asia such as China, India, Turkey etc, id possible as a result of the role of savings played. For example, China and some South East Asian countries have their savings rates in the range of 30-40 percent (Agrawal, Sahoo, & Dash, 2007). The decline in savings will reflect on the economic growth and development. One interpretation asserts that the low savings rate will induce low behaviour and will lead to low capital accumulation. West Africa’s savings performance is far below that of North and Middle Africa, some of the best savings rates in West Africa may be found in Nigeria and Cote d’Ivoire where the gross domestic savings rate has averaged in Nigeria 17.5% in 1980 to 89, 24.0% in 1990 to 1999 and 35.6%in 2000 to 2005 respectively and in Cote d’Ivoire with an average gross domestic savings rate of 19.6% in 1980 to 1989, 17.8% in 1990 to 1999 and 20.8% in 2000 to 2005 respectively. According to Mckinnon and Shaw (1973) assumed that restriction on financial instrument like interest rate ceiling, high reserve requirement and directed credit policies would hinder financial deepening and hence reduce growth, they also stressed the potential role of higher interest rates in mobilizing savings that could be put to productive use. According to them, a developed financial sector is expected to increase the savings by raising the efficiency of financial intermediation. On the other hand, a more developed financial system has potential to provide alternative saving instruments which are more suited for individual preferences (Schmidt-Hebbel and Serven, 2002)

  • Problems to the Study

West African countries are facing many economic problems like unemployment, rapid growth of population, slow economic growth, and low rates of national savings which is undesirable for the sustainable economic development. The savings rate in most West African counties have been weakened, while according to economic concepts for financial development, the required savings rate is 22-25%. National saving is very important in an economy and has a huge role to play in its development. Most of the time, whenever we look at economic data of different countries, our focus is on variables like unemployment rate, GDP growth, Inflation rate, Interest rate, Money supply growth, trade deficit and so on.  National saving is often not one of our focuses but it has a lot to do in the shaping of these variables.  Abdul-Malik and Baharumshah (2007) reported that countries having higher savings rates are also enjoying the higher growth rate and per capita income. Having a high rate of saving helps a country to face many huge development projects without having to borrow out of the country.  The effects on economics aggregates are then positive.  However, savings can be influenced by different factors. A comparison of West Africa rate of savings, with that of other regions of Africa, shows that the region has performed poorly throughout, the period of study. In the period 1980-1985, the North Africa had the highest savings rate of 22.1%, Middle Africa follows at a distant rate, with 9.9 per cent. West Africa savings rate stayed at a very disturbing low rate of 6.1 per cent. Although, the savings rate in West African increased from 6.6 percent in 1980-85 to 7.8 per cent in the period 1985-1990, the region continued to trail behind all other regions except South Africa. The period of 1990-1995 and 1995-2000, still left West Africa trailing behind North and Middle Africa sub-regions. Even, in the recent period of 2000-2006 when most countries witnessed some growth the rate of savings in West Africa was still below 10 per cent. African financial systems, most especially the West African are among the smallest across the globe, both in absolute terms and relative to economic activity. Many African financial systems are smaller than a mid-sized bank in continental Europe, with total assets often less than US$1 billion. The small size is connected to low productivity and skill shortages, and prevents bank from exploiting scale economics. Banking is very expensive in West Africa, as reflected by high interest rate spreads and margins and very high minimum balance requirements and annual fees not only for checking customers but even for savings account holders in many African countries which explain why less than 20 percent of the population in many West African countries has a bank account. The spreads between deposit and lending interest rates provides disincentives for both savings and lending, as it depresses the returns for savers and pushes lending interest rates up. High spreads, margins and overhead cost can be explained by the same factors as low levels of financial depth. Financial sector plays critical role in the development of money economy; it has been seen as a critical aspect in expansion ofe credit and provides the critical link between the savers and investors. This in effect means that with limited financial development, the risk element will be high due to lack of competition in the financial sector Eshaang (1983). To handle the credit rick due to distress borrowing and poor macroeconomic conditions bank and other financial institutions charge high premium to their interest rates. This in itself is darw back as it limits the economic growth of the country due to the high interest rates, the interest charged by these financial institutions are informed by inflation, real interest rate, policy of the government and their internal cost of operation (Owuor, 2014). However, the status of government interventions in financial market in most developing countries especially ECOWAS nations has hindered the great potential of all financial and money markets in increasing mobilizing savings that would lead to better growth and development. Various studies have also been carried out investigating the impact of interest rate and savings on financial development Akinlo and Egbetunde (2010), Agbetsiafe (2004), Abu-Bader and Abu-Qaran (2008) and Odhiambo (2007) including the Sub-Saharan Africa, developing and developed countries; the resultant conclusion has been very clear due to the very nature of interest rate. Also a number of studies have been carried out in Sub-Saharan African which indicates that there is still low financial access and interest rate has been found to have impacted on the growth of developing countries (Odhiambo, 2009). Again, the efficiency of all financial markets in financial development, interest rate and savings initiatives of financial resources has not been fully researched on and there still exist gaps in policy, research works and market participants in itself makes a great drawback on financial development. This further bolster the suggestions that there still exist knowledge gap which this study will try to answer. To this end, the paper will look at the interest rate and savings on financial development in West African countries with the use of panel data analysis.

  • Research Questions

The following are the research questions of the study.

  • How has interest rate impacted on financial development in some selected West Africa?
  • How has savings impacted on financial development in some selected West Africa?
  • What is the effect of financial development to economic growth in some selected West Africa?
  • Research Objectives

The general objective of this study is to investigate interest rate and savings on financial development in West Africa. Specific objectives are as follows

  • To investigate the impact of interest rate on financial development in some selected West Africa.
  • To investigate savings on financial development in some selected West Africa.
  • To ascertain the effect of financial development on economic growth in some selected West Africa.

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