Monetary Policy and Banking System Distress in Nigeria

Abstract

This paper investigated the extent, to which monetary policy influences the possibility of bank distress in Nigeria, and whether monetary policy adjustments have complimentary short- and long-run effects on banking industry stability, using time series data from 1989 to 2018. The study employed the Z-Score to measure the probability of banking system distress, hence, overall stability of the banking system, with the inclusion of institutional and macroeconomic indicators, as control variables. Findings from the study showed that, MPR, a measure of monetary policy, had mixed results: it was negative and significant in the long run (inter-temporal OLS) model, suggesting that, raising policy rate reduces the likelihood of banking system distress. However, MPR coefficient was positive and significant in the short run (ECM) differenced equation, which suggests that, a higher regime of MPR beyond a threshold distorts banking system stability due to elevated risk-taking behaviours of economic agents that may cause higher NPLs accumulation. The extent of economic openness showed mixed results, suggesting that openness to external environment can be a blessing or curse. In this regard, the study recommends the need for monetary authorities to develop effective framework for the conduct of monetary policy in Nigeria to support the banking system development, as well as for policy makers to urgently undertake economic and institutional reforms to generate a non-declining contribution of monetary policy instruments to the development of an inclusive financial system in Nigeria.

Keywords: Monetary policy, bank distress, z-score, economic openness, financial system

JEL Classification: E44, E52, G21