Global Journal of Human Resource Management

Vol.1, No. 3, pp. 12-28, September 2013

Published By European Centre for Research Training and Development UK (www.ea-journals.org)

A PANEL DATA ANALYSIS OF THE IMPACT OF INFORMALITY ON THE

LIQUIDITY OF DEPOSIT MONEY BANKS IN NIGERIA

Jonathan Emenike Ogbuabor,1* Victor A. Malaolu2 and Ifeoma C. Mba1

1 Department of Economics, University of Nigeria, Nsukka, Enugu State, Nigeria

2 CBN Enterpreneurship Development Centre (EDC), Lagos, Nigeria

ABSTRACT: One of the major components of the overall Nigerian economy is the informal
sector. Transactions in this sector are conducted mainly in cash to avoid official detection, and
this is capable of starving the banking system of the deposits needed to improve its liquidity. This
study empirically examined the impact of informality on the liquidity of the banking system in
Nigeria. The results indicate that informality impacts negatively on the liquidity of deposit money
banks in Nigeria. Specifically, we found that a unit increase in the size of the informal sector
results in 7.44% deterioration in the liquidity of deposit money banks. Based on these findings,
the study recommends that deposit money banks in Nigeria should pursue policies and products
that will assist them to capture the huge economic activities taking place in the informal sector,
while the government (through the Central Bank of Nigeria, CBN) should also reconsider its
policies that are capable of driving economic units underground. The study concludes that
deposit money banks in Nigeria must work together with the CBN to achieve an all inclusive
banking system, thereby reducing the negative impact of informality on the liquidity of deposit
money banks in Nigeria.

KEY WORDS: Informality; Bank Liquidity; Panel Analysis; CBN; Nigeria

INTRODUCTION

Globally, the adequacy of liquidity plays very crucial roles in the successful functioning of all
business firms. However, the issue of liquidity, though important to other businesses, is most
paramount to banking institutions. Here, bank liquidity may be defined as the ability of banks to
meet maturing obligations without incurring unacceptable losses. Liquidity shortage, no matter
how small, can cause great damage to a bank’s operations. Liquidity crisis, if not properly
managed, can instantly destroy those good customer relationships built over the years. Managing
liquidity is therefore a core daily process requiring bank managers to monitor and project cash
flows to ensure that adequate liquidity is maintained at all times. Functionally, deposit money
banks are financial institutions or intermediaries that mobilize deposits from the public and
create deposit money by granting loans, advances and overdrafts to their customers and in the
process earn profits on their investors’ funds. This definition emphasizes the consensus in
theoretical literature that profitability and liquidity constitute the most prominent issues in
corporate finance literature (Agbada & Osuji, 2013).

12
 Global Journal of Human Resource Management
Vol.1, No. 3, pp. 12-28, September 2013
Published By European Centre for Research Training and Development UK (www.ea-journals.org)

Generally, banks strive to strike a balance between profitability and liquidity (Niresh, 2012). The
provision of sufficient liquidity to customers at all times is an essential feature of banking. To
achieve this goal, banks ensure that sufficient provision of cash and other near cash securities are
made available to meet withdrawal obligations and new loan demand by customers in need of
liquidity. For this reason, banks in Nigeria are statutorily required to comply with the Cash
Reserve Requirement (CRR) policy of the Central Bank of Nigeria (CBN) as a means of
effectively managing the liquidity positions of banks. As a matter of fact, the first strategy to
liquidity management in Nigeria is compliance with this statutory reserve requirement and
liquidity ratios as stipulated by the CBN. Other strategic measures recently employed by the
CBN to improve banking system liquidity and stability and a steady flow of credit to the real
sector of the economy include the provision of guarantee on interbank transactions, the reduction
of the Standing Deposit Facility (SDF) rate from 2.0 to 1.0 per cent, the approval of a N500.00
billion intervention fund (N200 billion for refinancing and restructuring of DMBs’ facilities to
manufacturing enterprises) and the setting up of the Asset Management Corporation of Nigeria
(AMCON) (Agbada & Osuji, 2013).

Deposit money banks have been globally acknowledged for their unique role as an engine of
growth and development in any economy. Their intermediation role can be said to be a catalyst
for economic growth and development as investment funds are mobilized from the surplus units
in the economy and made available to the deficit units (Adegbaju & Olokoyo, 2008; Kolapo,
Ayeni & Oke, 2012; Mohammed, 2012). Generally, deposit money banks provide an array of
financial services to their customers through which deposits are mobilized from the banking
public while credits granted for investment purposes. It can therefore be said that the effective
and efficient performance of the banking industry is an important foundation for the financial
stability of any nation. The extent to which banks extend credit to the public for productive
activities accelerates the pace of a nation’s economic growth as well as the long-term
sustainability of the banking industry (Kolapo, Ayeni & Oke, 2012; Mohammed, 2012).
Summarily put, the banking institution occupies a vital position in the stability of the nation’s
economy. It plays essential roles on fund mobilization, credit allocation, payment and settlement
system as well as monetary policy implementation (Mohammed, 2012). In performing these
functions, it must be emphasized that banks in turn promote their own performance and health.
In other words, deposit money banks usually mobilize savings and extend loans and advances to
their numerous customers bearing in mind, the three principles guiding their operations, which
are profitability, liquidity and safety (Okoye & Eze, 2013).

In Nigeria, Imala (2005) stated that the main objectives of the banking system are to ensure price
stability and facilitate rapid economic development through their intermediation role of
mobilizing savings and inculcating banking habit at the household and micro enterprise levels.
Unfortunately, these objectives have remained largely unattained as a result of some deficiencies
in the country’s banking system. Some of these deficiencies include: low capital base, a large
number of small banks with relatively few branches, the dominance of a few banks, poor rating
of a number of banks, weak corporate governance evidence by inaccurate reporting and non
compliance with regulatory requirements, eroded shareholders fund caused by operating losses,

13
 Global Journal of Human Resource Management
Vol.1, No. 3, pp. 12-28, September 2013
Published By European Centre for Research Training and Development UK (www.ea-journals.org)

over dependence on public sector deposits, foreign exchange trading and the neglect of small and
medium scale private savers, and insolvency as evidenced by negative capital adequacy ratios of
some banks. In view of these defects, Imala (2005) asserted that the Nigeria banking sector plays
marginal role in the development of the real sector.

From the foregoing, it can be seen that the savings mobilization efforts and liquidity of deposit
money banks in Nigeria can be seriously hampered by the presence of a huge informal sector.
This is due to the fact that most informal sector transactions are conducted in cash to avoid
official detection (Oduh et. al, 2008; Buehn & Schneider, 2008). Unfortunately, recent empirical
evidences point to a growing informal sector in Nigeria (Ogbuabor & Malaolu, 2013; Ariyo &
Bekoe, 2012; Oduh et al, 2008). The objective of this study is to empirically examine the impact
of the informal sector on the liquidity of deposit money banks in Nigeria. This became necessary
in order to provide evidence based policies that will enhance the stability and soundness of the
banking sector and the overall economy in Nigeria.

This study is of great significance in view of the assertion by Soludo (2004) that many banks in
Nigeria appear to have abandoned their essential intermediation role of mobilizing savings and
inculcating banking habit at the household and micro enterprise levels. Worse still, the
indifference of banks towards small savers and informal sector operators, particularly at the
grass-roots level, has not only compounded the problems of low domestic savings and high bank
lending rates in the country, it has also reduced access to relatively cheap and stable funds that
could provide a reliable source of credit to the productive sectors at affordable rates of interest.
Imala (2005) also commented that the current structure of the banking system has promoted
tendencies towards a rather sticky behaviour of deposit rates, particularly at the retail level, such
that, while banks' lending rates remain high and positive in real terms, most deposit rates,
especially those on savings, are low and negative. In addition, savings mobilization at the grass-
roots level has been discouraged by the unrealistic requirements, by many banks, for opening
accounts with them. This study is therefore a major step towards promoting a solid and stable
financial sector that is essential for a well functioning national economy in Nigeria.

THEORETICAL LITERATURE (THEORIES OF INFORMALITY)

In this study, we shall adopt the definition of the informal sector as provided by Smith (1994).
He conceptualized informal activities as those economic activities that are market-based
production of goods and services, whether legal or illegal, that escape detection in the official
estimates of GDP. There are four main theories of informality in the literature. These include:
modernization, dependency, structuralism and neo-liberalism theories (Yusuff, 2011).

Modernization Theory: The main proponent of the modernization theory is Rostow (1960). He
characterized informality in the less developed countries largely as a “social problem” internal to
and caused by the backward socio-economic systems of individual countries. According to him,
the policy prescription was for these countries to acquire “modern” values, “modern” legal
institutions and political systems, and “modern” capitalist economies. In most cases, the

14
 Global Journal of Human Resource Management
Vol.1, No. 3, pp. 12-28, September 2013
Published By European Centre for Research Training and Development UK (www.ea-journals.org)

“modern” was understood as being synonymous with western values, institutions, and market
economies. In essence, the issue of informality is not rooted in capitalist exploitation and
extraction (as argued successively by neo-Marxist and dependency theorists), rather these
countries had not yet been sufficiently incorporated into the modern world or the international
economy. Thus, it is only a matter of time and these countries would “take-off” and “catch-up”
with the developed countries. Proponents of modernization theory saw the informal sector as a
remnant of traditional, pre-capitalist modes of production and subsistence strategies common to
isolated rural communities such that informal sector economic units were trapped outside the
modern economy because they lacked proper education, skills, and value orientations. The main
weakness of the modernization theory is that the informal sector is neither seen as an important
component of the overall economy that can engender economic growth, nor as a reservoir of
entrepreneurial training and talent. It is seen as a problem to be solved and not a development
strategy to be harnessed and promoted.

Dependency Theory: It was the pioneering works of ILO (1972) and Hart (1973) that
crystallized the phenomenon of unregulated economic activity into the term “informal sector”.
Hart’s contribution had such a broad and original impact because he focused on the complex,
organized, and dynamic income generating activities of informal enterprises. In effect, he found
that informal activities were not a mere extension of traditional subsistence strategies and that
participants in these unregulated activities were not universally condemned to poverty and
marginality. However, other scholars working within the dependency tradition had characterized
informal workers as universally poor and emphasized the sector’s supposed marginal position
vis-à-vis the modern capitalist sector (Portes & Schauffler, 1992). Furthermore, in terms of
developing a systematic definition of what constituted the informal sector, proponents of the
dependency theory (such as Tokman, 1978; PREALC, 1978), often described the many common
characteristics of enterprises in the sector. These characteristics include: little capital, low
technology and production, little profits, utilization of unpaid family labour, easy entry and exit,
low efficiency and competition. Furthermore, the dependency approach saw the goal of informal
activities as mere survival, not profit maximization. Informal firms were often characterized as
taking advantage of their ability to avoid taxes and regulations and exploiting niche areas
overlooked by larger and less flexible firms. The weakness of the dependency theory is that it
sees the informal labour arrangement as taking place largely outside the exploitative formal
relations of production. As such, the informal sector was viewed largely with suspicion as a mere
transposition of the rural subsistence sector into the urban environment.

Structuralism: Structuralists insist that informality is not simply the result of excess labour
supply, or over-regulation. Instead, the central element of the structuralists’ theory is the
insistence that informality is in essence an alternate form of labour utilization (and often
exploitation) by capital. Put differently, Maloney (2004) stated that informal sector workers are
not just there by some accident or flaw in capitalist development. Instead, these workers are
actively “informalized” by capital under the logic of peripheral capitalist accumulation. A critical
shortcoming of this theory is that while industrial subcontracting is a central feature of informal
activities in Latin American cities, it is a comparatively insignificant feature of informal sector

15
 Global Journal of Human Resource Management
Vol.1, No. 3, pp. 12-28, September 2013
Published By European Centre for Research Training and Development UK (www.ea-journals.org)

activities in developing countries like Nigeria. The common feature in African informal sector is
the ‘subsistence’ informal economy in which economic actors are fully occupied in informal
means of income generation (Capecchi, 1989; Ishola, 2008).

Neo-liberalism Theory: Neo-liberalism is an ideology based on economic liberalism. The

ideology favours economic policies that minimize the role of the state and maximize the private
business sector. Neo-liberalism seeks to transfer control of the economy from public to the
private sector under the belief that it will produce a more efficient government and improve the
economic health of the nation. According to De Soto (1989), a key proponent of this ideology,
the informal sector is a response to excessive state regulations and other unfavourable
macroeconomic conditions. This theory subscribes to the notion that the informal sector
comprises entrepreneurs who choose to operate informally in order to avoid the costs of formal
registration and other unfavourable conditions in the business environment. Proponents of neo-
liberalism believe that entrepreneurs would continue to produce informally so long as
government procedures are cumbersome and costly, property rights remain deficient and
accessibility to productive resources like finance and technology remain elusive. Under this
ideology, those entrepreneurs who generate income for themselves and their families in the
informal sector are regarded as the ‘real revolutionaries’, who heroically stand up to the tyranny
of excessive state regulations; those informal workers are the real seeds of the free market
(deregulatory) doctrine.

THE NIGERIAN INFORMAL SECTOR

Tanzi (1983) claimed that in a well-working market economy, without a public sector, there
would be no underground activities. This is because the major causes of informal activities in
many countries including Nigeria are largely traceable to imposition of taxes and import duties,
the need to adopt regulatory and control measures in the domestic or external sector of an
economy. For example, the impositions of quantitative restrictions on trade, the need to define
and enforce territorial boundaries, bureaucratic corruption, etc are potential causes of
informality. Also, the higher the marginal tax rates, the greater the cost of being honest and the
more the incentive to evade or understate personal and corporate incomes. Furthermore, the fact
that tariff on imports and import quotas create incentive to smuggle is well emphasized in
literature. The fixing of over-valued exchange rate of a national currency supported by exchange
control measures that rely on trade restrictions usually herald the emergence of a black market
for foreign exchange as economic agents devise means of evading the controls. In general, the
more regulated an economy is, the more will activities that are difficult to control emerge as
people design and execute plans to side-track the regulations; and herein lies the origin of
informal sector activities (Oresotu, 1996; Tanzi, 1983).

In Nigeria, Akerele (2005) reported that before and years after independence, the Nigerian
economy was predominantly rural and agrarian. Cash crops such as palm produce, ground nut,
and cocoa as well as minerals such as tin ore, columbite, and zinc were major foreign exchange
earners. These activities were carried out by individuals and small-holder enterprises. It is

16
 Global Journal of Human Resource Management
Vol.1, No. 3, pp. 12-28, September 2013
Published By European Centre for Research Training and Development UK (www.ea-journals.org)

obvious that these activities were mainly performed by informal sector operators. Olowu and
Okotoni (1996) provided more insights on the Nigerian informal sector. According to them, the
Nigerian informal sector has two major components: the economic and financial segment; and,
the administrative/political segment. The economic and financial segment comprises the large
members of highly competitive but poorly capitalized small-scale operators and the financial
institutions needed to sustain their businesses. It manifests itself in the economic activities
designed and managed by the people of a given community aimed at providing goods and
services that are required by the generality of the people. Through these activities, a mass of
goods and services are produced both in the agricultural and non-agricultural sectors. Operators
in this sector do not have access to large capital (available in the formal sector) or legal
protection and often exist on the fringes of the law. They rely on informal structures and contacts
with the formal system to survive. Nevertheless, they employ a large proportion of the
productive labour force (especially women) and rely on indigenous technology and innovations.

Members of a particular trade organize themselves into association, union, or guild. Such
associations are designed to cater for the interest of members while non members are not allowed
to practice in that community. Rules and regulations are made to guide the associations,
sanctions are used to deal with erring members, and periodic (weekly or monthly) levies are
collected to maintain the associations and provide credits to members, often on a rotating basis.
Other sources of informal finance include gifts and loans from family members, friends,
specialized savings and credit associations such as esusu, adashi, bam in different parts of the
country. Essentially, these associations protect the economic interests of members, protect
members from harassment from any quarter, and speak with one voice on behalf of their
members (Olowu & Okotoni, 1996).

The Nigerian informal economy covers a wide range of activities. These include several small-
scale and unregistered sole-proprietor businesses, and in some instances, joint-partnership
businesses which can be found in both rural and urban settlements across the country. In this
informal economy, tax evasion is very rampant as income is unmeasured and unrecorded. In fact,
their activities are not fully reflected in the national accounts, and thus, unrecorded by the state.
The nature of the economic activities engaged in varies considerably from one locality to
another. For example, in the rural areas, farming activities and allied occupations such as
hunting, fishing, blacksmithing, weaving, basket and pot making, as well as leather works are
more prevalent. However, in urban centres like Lagos, Enugu, Abuja, Kano, Ibadan, and Jos, the
informal economic activities include trading, small-scale manufacturing and repairing industries,
such as carpentry, upholstery, furniture making, woodworks, metalworks, bakery, tailoring,
bricklaying, and printing. Those in the area of repairing occupations include, among others, the
automobile mechanics, electricians, clock and watch repairers and cobblers (Olowu & Okotoni,
1996).

17
 Global Journal of Human Resource Management
Vol.1, No. 3, pp. 12-28, September 2013
Published By European Centre for Research Training and Development UK (www.ea-journals.org)

THE EVOLUTION OF THE NIGERIAN BANKING SECTOR

According to Osamor, Akinlabi & Osamor (2013), banking operation began in Nigeria in 1892
under the control of the expatriates and by 1945, some Nigerians had established their own
banks. The first era of consolidation ever recorded in Nigeria banking industry was between
1959 and 1969. This was occasioned by bank failures during 1953-1959 due to liquidity
challenges faced by the banks. There was no well-organized financial system with enough
financial instruments to invest in. Hence, banks merely invested in real assets which could not be
easily realized to cash without loss of value in times of need. This prompted the Federal
Government then, backed by the World Bank Report to institute the Loynes Commission in
September 1958. The outcome was the promulgation of the Ordinance of 1958, which
established the Central Bank of Nigeria (CBN). The year 1959 was remarkable in the Nigeria
Banking history not only because of the establishment of Central Bank Nigerian (CBN) but also
because of the Treasury Bill Ordinance that was enacted which led to the issuance of the first
treasury bills in April, 1960.

The period (1959–1969) marked the establishment of formal money, capital markets and
portfolio management in Nigeria. In addition, the Company Acts of 1968 were established. This
period could be said to be the genesis of serious banking regulation in Nigeria. With the CBN in
operation, the minimum paid-up capital was set at ₦400,000 (USD$480,000) in 1958. By
January 2001, banking sector was fully deregulated with the adoption of universal banking
system in Nigeria which merged merchant bank operations with commercial banks system
preparatory to the consolidation programme in 2004. In the 1990s, proliferation of banks which
also resulted in the failure of many of them, led to another recapitalization exercise that saw
bank’s capital being increased to ₦500million (USD$5.88 million) and subsequently to
₦2billion (US$0.0166billion) in 2004 with the institution of a 13-point reform agenda aimed at
addressing the fragile nature of the banking system, stopping the boom and burst cycle that
characterized the sector and evolving a banking system that not only could serve the Nigeria
economy, but also the regional economy. The agenda by the monetary authorities is also to
consolidate the Nigeria banks and make them capable of playing in the international financial
system.

However, there appears to be differences between the state of the banking industry in Nigeria
vis-à-vis the vision of the government and the regulatory authority. This, in the main, was the
reason for the policy of mandatory consolidation, which was not open to dialogue and its
components also seemed cast in concrete. In terms of number of banks and minimum paid-up-
capital, between 1952 and 1978, the banking sector recorded forty-five (45) banks with varying
minimum paid-up capital for merchant and commercial banks. The number of banks increased to
fifty-four (54) between 1979 and 1987, and further rose to one hundred and twelve (112)
between 1988 and 1996 with substantial varying increases in the minimum capital. The number
of banks dropped to one hundred and ten (110) with another increase in minimum paid-up capital
and finally dropped to twenty-five (25) in 2005 with a big increase in minimum paid-up capital

18
 Global Journal of Human Resource Management
Vol.1, No. 3, pp. 12-28, September 2013
Published By European Centre for Research Training and Development UK (www.ea-journals.org)

from ₦2billion (USD$0.0166billion) in January 2004 to ₦25billion (USD$0.2billion) in July

2004 (Somoye, 2008). After the consolidation, the number of banks later reduced to twenty-three
(23), due to the merger of some banks. These banks are saddled with the following functions
among others: acceptance of deposits from customers, provision of credit facilities in form of
loans and overdrafts, management of customer’s portfolio of investment and provision of
investment advice

THE CONCEPT OF BANK LIQUIDITY

Liquidity may be viewed as a measure of the relative amount of asset in cash or which can be
quickly converted into cash without any loss in value available to meet short term liabilities,
while liquid assets are composed of cash and bank balances, debtors and marketable securities;
liquidity is the ability of a firm to meet all obligations without endangering its financial
conditions (Olagunju, Adeyanju & Olabode, 2011). According to Agbada and Osuji (2013), bank
liquidity simply means the ability of the bank to maintain sufficient funds to pay for its maturing
obligations. It is the bank’s ability to immediately meet cash, cheques, other withdrawals
obligations and legitimate new loan demand while abiding by existing reserve requirements.
Bhattacharyya and Sahoo (2011) argued that Liquidity management by Central banks typically
refers to the framework, set of instruments, and the rules that the monetary authority follows in
managing systemic liquidity, consistent with the ultimate goals of monetary policy. In this
regard, central banks modulate liquidity conditions by varying both the level of short-term
interest rates and influencing the supply of bank reserves in the interbank market. Effective
liquidity management is a key factor that helps sustain bank profits and concurrently keeps the
banking institution and the financial system generally from illiquidity and perhaps, insolvency.
In order to maintain public confidence on the financial system of the country, banks are required
to maintain adequate amount of cash and near cash assets such as securities to meet withdrawal
obligations. It is paramount for the survival of the totality of the financial system of a country
and the banks in particular whose core function of financial intermediation depend on the
availability of adequate liquidity.

In Nigeria, the challenges of inefficient liquidity management in banks were brought to the fore
during the liquidation and distress era of 1980s and 1990s, which lingered up to the re-
capitalization era in 2005 in which banks were mandated to increase their capital base from N2
billion to N25 billion. The recapitalization exercise was expected to stabilize and resolve the
liquidity challenges that were prevalent in the economy. However, barely five years after what
was applauded and considered as a fortified repositioning of banks against liquidity shortage, the
Central Bank of Nigeria (CBN) in 2009 came on a rescue mission to save five illiquid banks. The
CBN injected N620b to save the affected five banks that were operating on negative
shareholder’s funds, while the Asset Management Corporation of Nigeria (AMCON) was set up
to buy the bad debts of affected banks (Agbada & Osuji, 2013).

Prudence requires that the liquidity position of a bank should be ascertained, monitored and
controlled daily. The liquidity of an entity requires that its ability to pay its debts when due and

19
 Global Journal of Human Resource Management
Vol.1, No. 3, pp. 12-28, September 2013
Published By European Centre for Research Training and Development UK (www.ea-journals.org)

the ability of its debtors to pay the amount they owe to the entity are of great importance.
However, the liquidity or solvency of a firm is usually measured by liquidity ratios, which are a
class of financial ratios used to determine a company’s ability to honour its short-term debt
obligations (Wood & Sangster, 2005; Agbada & Osuji, 2013; Loth, 2012). Commonly used
liquidity ratios are the current ratio and the quick ratio (also known as the acid test ratio). The
current ratio is used to test a firm’s liquidity because it shows the proportion of the firm’s current
assets available to cover its current liability. The concept behind this ratio is to ascertain whether
a company’s short-term assets (such as cash, cash equivalents, marketable securities, receivables
and inventory) are sufficient to pay its short-term liabilities (notes payable, current portion of
term debt, payables, accrued expenses and taxes). The only difference between the current and
acid test ratios is that inventory is omitted frosm the acid test ratio (Loth, 2012). In this study, we
shall use the ratio of total loan-to-total deposit as a measure of the liquidity of the deposit money
banks (Fadare, 2011).

REVIEW OF EMPIRICAL LITERATURE

Agbada and Osuji (2013) studied the efficacy of liquidity management and banking performance
in Nigeria using survey research methodology. Data obtained were first presented in tables of
percentages and pie charts and were empirically analyzed by Pearson product-moment
correlation coefficient (r). Findings from the empirical analysis were quite robust and clearly
indicate that there is significant relationship between efficient liquidity management and banking
performance and that efficient liquidity management enhances the soundness of bank.

Aremu (2011) examined the liquidity series of Nigerian banks by applying multiple regression
analysis using error correction mechanism and Johansen cointegration to time series data
collected from three major banks. The results show that the proxies of liquidity series of two of
the banks are significant. Uremadu (2012) examined the effect of bank capital structure and
liquidity on profitability using Nigerian data for the period 1980-2006 and applying an OLS
methodology. The study found a positive influence of cash reserve ratio, liquidity ratio and
corporate income tax; and a negative influence of bank credits to the domestic economy, savings
deposit rate, gross national savings (proxy for deposits with the central bank), balances with the
central bank, inflation rate and foreign private investments, on banking system profits. It also
found that liquidity ratio leads banks’ profits in Nigeria, closely followed by balances with the
central bank and then, gross national savings and foreign private investments,followed suit in
that order. Olagunju, Adeyanju and Olabode (2011) examined liquidity management and
commercial banks’ profitability in Nigeria by analyzing both primary and secondary data. The
results indicate that the profitability of commercial banks is significantly influenced by their
liquidity and vice versa.

Fadare (2011) employed a linear least square model and time series data from 1980 to 2009 to
examine the determinants of Banking Sector liquidity in Nigeria and assesses the extent to which
the recent financial crises affected liquidity in deposit money banks in the country. The findings
indicate that only liquidity ratio, monetary policy rate and lagged loan-to-deposit ratio are

20
 Global Journal of Human Resource Management
Vol.1, No. 3, pp. 12-28, September 2013
Published By European Centre for Research Training and Development UK (www.ea-journals.org)

significant for predicting Banking Sector liquidity; and that a decrease in monetary policy rates,
liquidity ratios, volatility of output in relation to trend output, and the demand for cash, leads to
an increase in current loan-to-deposit ratios; while a decrease in currency in circulation in
proportion to Banking Sector deposits; and lagged loan-to-deposit ratios leads to a decline in
current loan-to-deposit ratios. The result suggests that during periods of economic or financial
crises, deposit money banks are significantly illiquid relative to benchmarks, and getting
liquidity monetary policies right during these periods is crucial in ensuring the survival of the
Banking Sector.

Kolapo, Ayeni and Oke (2012) carried out an empirical investigation into the quantitative effect
of credit risk on the performance of commercial banks in Nigeria over the period of 11 years
(2000-2010) using five commercial banking firms. Panel model analysis was used to estimate the
determinants of the profit function. The results showed that the effect of credit risk on bank
performance measured by the Return on Assets of banks is cross-sectional invariant. That is the
effect is similar across banks in Nigeria, though the degree to which individual banks are
affected is not captured by the method of analysis employed in the study.

Adegbaju and Olokoyo (2008) investigated the impact of previous recapitalization in the banking
system on the performance of the banks in Nigeria with the aim of finding out if the
recapitalization is of any benefit. The study employed secondary data obtained from NDIC
annual reports. The results indicate that the mean of key profitability ratios such as the Yield on
earning asset (YEA), Return on Equity (ROE) and Return on Asset (ROA) were significant
meaning that there is statistical difference between the mean of the bank before 2001
recapitalization and after 2001 recapitalization.

Osamor, Akinlabi and Osamor (2013) examined the impact of globalization on performance of
Nigerian commercial banks between 2005 and 2010, using panel data econometrics in a pooled
regression, where time series and cross-sectional observations were combined and estimated.
The results of econometric panel regression analysis confirmed that globalization, i.e. foreign
private investment, foreign trade and exchange rate have positive effects on the profit after tax of
banks.

Beck, Cull and Jerome (2005) examined the effect of privatization on performance in a panel of
Nigerian banks for the period 1990-2001. The results showed evidence of performance
improvement in nine banks that were privatized, which is remarkable given the inhospitable
environment for true financial intermediation. The results also suggest negative effects of the
continuing minority government ownership on the performance of many Nigerian banks; and
also showed aggregate indications of decreasing financial intermediation over the 1990s, banks
that focused on investment in government bonds and non-lending activities enjoyed a relatively
higher performance.

Olokoyo (2012) examined the effects of bank deregulation on bank performance in Nigeria. The
study analyzed secondary data collected from CBN statistical bulletin by employing the Ordinary

21
 Global Journal of Human Resource Management
Vol.1, No. 3, pp. 12-28, September 2013
Published By European Centre for Research Training and Development UK (www.ea-journals.org)

Least Square (OLS) technique. This study found out that the deregulation of the banking sector
has positive and significant effect on bank performance.
Barros and Caporale (2012) examined the Nigerian banking consolidation process using a
dynamic panel for the period 2000-2010. The Arellano and Bond (1991) dynamic GMM
approach was adopted to estimate a cost function taking into account the possible endogeneity of
the covariates. The main finding is that the Nigerian banking sector has benefited from the
consolidation process, and specifically that foreign ownership, mergers and acquisitions and
bank size decrease costs.

METHODOLOGY

A total of twenty commercial banks operate presently in Nigeria, out of which five banks were
selected for this study. The selected banks include First of Nigeria Bank Plc. (FBN), United
Bank for Africa Plc. (UBA), Guaranty Trust Bank Plc. (GTB), Zenith International Bank Plc.
(ZIB), and Access Bank Plc (ABP). The basis for the selection rests on the facts provided by
Kolapo, Ayeni and Oke (2012) that these banks have been rated as the topmost five Nigerian
banks by Fitch rating and Bankers’ Magazine of July 2012, they account for over fifty percent of
deposit liabilities in the Nigerian banking sector, they have made the list of the first 25 and 500
banks in Africa and the world respectively, their credit rating by Fitch, Standard and Poors, and
Agusto and Co have moved from stability to positive as at January 2012, they all have a large
customer base and participate actively on the Nigerian Stock Exchange (NSE). The study made
use of data obtained from the audited financial reports of the banks for a period of thirteen years
(2000- 2012), macroeconomic data obtained from the CBN Statistical Bulletin (2011) as well as
informal sector data from Ogbuabor & Malaolu (2013).
STATA 11 econometric software was used to analyze the data, using Panel Data Regression
model to capture both the cross sectional and time series data. A high coefficient of
determination will indicate objectivity. The Panel data Regression analysis was chosen instead of
simple or multiple regressions because it has the advantage of providing more informative data,
more variability, less collinearity among variables, more degrees of freedom and efficiency
(Gujarati & Porter, 2009). Besides, it is best suited to study ‘dynamics of change and more
complicated behavioural models, and has the capacity of enriching empirical analysis in ways
that may not be possible for ordinary regression or multiple analysis (Akintoye, 2008). Our
working hypothesis may be stated thus:
Ho: The informal sector does not impact on the liquidity of deposit money banks in Nigeria
H1: The informal sector impacts on the liquidity of deposit money banks in Nigeria

MODEL SPECIFICATION

Following Kolapo, Ayeni and Oke (2012), the model for this study can be implicitly stated as
follows:

LDRAT = f(INFOR, GDPGR, TCGDP, M1DEP, PAT, ASQUA, CAPAD)

……………………………….... (1)

22
 Global Journal of Human Resource Management
Vol.1, No. 3, pp. 12-28, September 2013
Published By European Centre for Research Training and Development UK (www.ea-journals.org)

Where: LDRAT = loan to deposit ratio (proxy for bank liquidity);

INFOR = informality (measured as size of Nigeria’s informal sector as % of GDP);
GDPGR = GDP growth rate:
TCGDP = total banking sector credit to GDP ratio;
M1DEP = ratio of M1 to total banking sector deposits
PAT = profit after tax
ASQUA = asset quality (measured as the ratio of total non-performing loans to total
loans);
CAPAD = capital adequacy ratio
Following Kolapo, Ayeni and Oke (2012) and Gujarati and Porter (2009), the fixed effects
within-group models of equations (1) and (2) can be econometrically and explicitly specified as
follows:

LDRATit = λ0i + λ1INFORit + λ2GDPGRit + λ3TCGDPit + λ4M1DEPit + λ5CAPADit +

λ6PATit + λ7ASQUAit + εit ………..………………………………………………………. (2)

Where:
λi are the parameters, t = 1, 2, 3, …, 13 is the time period, i = 1, 2, …, 5 is the cross-sectional
units and ε is the error term. Our a priori expectations are that λ2, λ5> 0 while λ1, λ3, λ4, λ6, λ7 < 0.
Our choice of the fixed effects within-group model is based on the following observations by
Gujarati and Porter (2009):
1. Fixed effects estimators are consistent where a long panel is involved and are preferred to
random effects estimators;
2. If the individual error components εi and one or more regressors are correlated, then the
random effects estimators are biased, whereas those obtained from fixed effects model
are unbiased;
3. Even if it is assumed that the underlying model is pooled or random, the fixed effects
estimators are always consistent.

EMPIRICAL RESULTS AND DISCUSSION

The parameter estimates from our regression results are shown in tables 1 below:
Table 1: Fixed-effects within-group regression results (LDRAT as dependent variable)
Variables Coefficients Standard Error t-statistic Probability
PAT -.19083 .1373052 -1.39 0.170
ASQUA .4191525 .3471135 1.21 0.233
CAPAD .10658 .2159981 0.49 0.624
INFOR -.0744681 .2345065 -0.32 0.752
M1DEP -.0047639 .0049114 -0.97 0.336
TCGDP .0278138 .0055006 5.06 0.000
GDPGR .4019615 .4757427 0.84 0.402
CONSTANT 36.78247 17.68762 2.08 0.042
23
 Global Journal of Human Resource Management
Vol.1, No. 3, pp. 12-28, September 2013
Published By European Centre for Research Training and Development UK (www.ea-journals.org)

R2 (within) = 0.4239; R2 (overall) = 0.1428; No of observations = 65; Prob. (F) = 0.0000

Source: Author’s computation using STATA 11

The results in Table 1 above indicate that total banking sector credit to GDP ratio (TCGDP)
coefficients is statistically significant at both 5% and 1% levels of significance and explained
about 14% of the overall variations in loan to deposit ratio (LDRAT), which is the proxy for
bank liquidity. This shows that the volume of credit granted by deposit money banks in Nigeria
is a key determinant of the liquidity of the banking system. The overall F-statistic is also
significant and indicates the objectivity of our model. However, even though informality is not
statistically significant, it has a negative coefficient of -0.0744681 which conforms to a priori
expectation. This result shows that the informal sector impacts negatively on the liquidity of
deposit money banks in Nigeria. Here, a unit increase in the size of the informal sector results in
7.44% deterioration in the liquidity of deposit money banks. Other repressor variables such as
GDPGR, PAT, M1DEP, and CAPAD also conformed to our a priori expectations, whereas
TCGDP and ASQUA did not conform. The negative coefficient of -0.0047639 for M1DEP
indicates that high currency in circulation required for informal transactions impacts negatively
on the liquidity of the banking system. Furthermore, the results indicate that whenever the
banking system increases profitability by one unit, its liquidity worsens by 19.1%.

CONCLUSION AND RECOMMENDATIONS

The informal sector in Nigeria is one of the major components of the overall economy. This
study has empirically examined the impact of informality on the liquidity of the banking system
in Nigeria. The results indicate that if bank liquidity is measured by total loan to deposit ratio,
then informality impacts negatively on the liquidity of deposit money banks in Nigeria. Other
variables that impact negatively on bank liquidity are ratio of M1 to total banking sector deposits
and profit after tax. However, GDP growth rate, asset quality and total credit to GDP ratio
impact positively on bank liquidity.

Based on the findings above, we recommend that deposit money banks in Nigeria should pursue
policies and products that will assist them to capture the huge economic activities taking place in
the informal sector and thereby improve the liquidity of the banking system in Nigeria. The
government, through the monetary authority (the Central Bank of Nigeria, CBN), should also
review and improve on its policies that are capable of driving economic units underground.
Electronic banking and other cashless measures can be used through well articulated policies,
including public enlightenment campaigns and provision of adequate information and
communication technology infrastructure that will encourage the banking public to embrace such
policies. Clearly, deposit money banks in Nigeria must work together with the CBN to achieve
an all inclusive banking system, thereby reducing the negative impact of informality on the
liquidity of deposit money banks in Nigeria.

24
 Global Journal of Human Resource Management
Vol.1, No. 3, pp. 12-28, September 2013
Published By European Centre for Research Training and Development UK (www.ea-journals.org)

REFERENCES

Adegbaju, A. A. & Olokoyo, F.O (2008). Recapitalization and Banks’ Performance: A Case Study
of Nigerian Banks. African Economic and Business Review, 6 (1), PP. 1 – 17.
Agbada, A. O. & Osuji, C. C (2013). The Efficacy of Liquidity Management and Banking
Performance in Nigeria. International Review of Management and Business Research, 2(1), pp.
223 – 233.
Akerele, W. O. (2005). The effects of economic adjustment on employment in the urban informal
sector of Ibadan city. NISER Mimeograph No. 3. Ibadan: NISER.
Akintoye, I. R. (2008). Sensitivity of Performance to Capital Structure. European Journal of Social
Sciences, 7(1),
pp. 23 – 31.
Aremu, A. M (2011). A Perspective on Liquidity and Assets Management of Commercial Banks in
Nigeria: Evidence from Some Selected Banks. Journal of Emerging Trends in Economics and
Management Sciences (JETEMS,) 2(6), pp. 454-460.
Ariyo, A. & Bekoe, W. (2012). Currency demand, the underground economy and tax evasion: The
case of Nigeria. Journal of Monetary and Economic Integration, 11(2).
Barros, C. P. & Caporale, G. M (2012). Banking Consolidation in Nigeria, 2000-2010. Working
Paper No. 12 – 06, Department of Economics and Finance, Brunel University, London
Beck, T., Cull, R. & Jerome, A (2005). Bank Privatization and Performance: Empirical Evidence
from Nigeria. World Bank Policy Research Working Paper 3511
Bhattacharyya, I. & Sahoo, S (2011). Comparative Statistics of Central Bank liquidity Management:
Some insights. Economic research International.
Brealey R. A, Myers S.C. & Marcus, A (2004). Fundamentals of Corporate Finance. New York:
McGraw
Hill, Irwin.
Buehn, A. & Schneider, F. (2008). MIMIC models, cointegration and error correction: An
application to the French economy. IZA Discussion Paper No. 3306, pp. 1 – 30.
Capecchi, V. (1989). The informal economy and the development of flexible specialization in
Emilia Romagna. In Portes, A. et al. (eds), The Informal Economy. Baltimore: Johns Hopkins
University Press, pp. 189-215.
CBN, (2012), Liquidity Management by the CBN - Central Bank of Nigeria;
www.cenbank.org/out/EducSeris.
CBN/FOS/NISER (2001). A Study of Nigeria’s Informal Sector, Volume 1.
De Soto, H. (1989). The other path. Translated by Abbott, J. & Sendero, E. (1987).Harper and Row,
New York.
Enyioko, Newman (2012). Impact of Interest Rate Policy and Performance of Deposit Money
Banks in Nigerian. Global Journal of Management and Business Research, Vol. 12 Issue 21
Version 1, pp. 23 – 30.
Fadare, S. O (2011). Banking Sector Liquidity and Financial Crisis in Nigeria. International
Journal of Economics and Finance, 3 (5), pp. 3 – 11.
Gujarati. D. N. & Porter, D. C (2009). Basic Econometrics, 5th Edition. New York: Mcgraw-Hill /
Irwin.

25
 Global Journal of Human Resource Management
Vol.1, No. 3, pp. 12-28, September 2013
Published By European Centre for Research Training and Development UK (www.ea-journals.org)

Hart, K. (1973). Informal income opportunities and urban employment in Ghana. Journal of
Modern African Studies, 2(1), pp. 62-89.
Imala O. I (2005). Challenges of Banking Sector Reforms & Bank Consolidation in Nigeria. CBN
Bullion, 29(2).
Kolapo, T. F., Ayeni, R. K. & Oke, M. O (2012). Credit risk and commercial banks’ performance in
Nigeria: A panel model approach. Australian Journal of Business and Management Research, 2
(2), 31 – 38.
Ishola R. A. (2008). Reducing unemployment through the informal sector: A case study of Nigeria.
European Journal of Economics, Finance and Administrative Sciences, 11.
Loth, R (2012). Liquidity Measurement Ratio: Current Ratio. Investopedia. Retrieved from
www.investopedia.com
Maloney, W.F. (2004). Informality revisited. World Development, 32 (7), pp. 1159-78.
Mohammed, Fatimoh (2012). Impact of Corporate Governance on Banks Performance in Nigeria.
Journal of Emerging Trends in Economics and Management Sciences (JETEMS), 3(3), 257-260.
Nikolai, L. & Bazlay, J.D (1997). Intermediate Accounting. Ohio: South-Western College
Publishing.
Niresh, J.A (2012). Trade-off between liquidity and profitability: A study of selected manufacturing
firms in
Sri-lanka. Journal of Arts and Science and Commerce, 4 (2).
Rose, P. S (2001). Commercial Bank Management 5th Edition. McGraw-Hill Irwin
Oduh, M., Eboh, E., Ichoku, H. & Ujah, O. (2008). Measurement and explanation of informal sector
of the Nigerian economy. AIAE Research Paper 3, pp. 1-64.
Ogbuabor, J. E. & Malaolu, V. A (2013). Size and Causes of the Informal Sector of the Nigerian
Economy: Evidence from Error Correction MIMIC Model. Journal of Economics and
Sustainable Development, 4(1).
Okoye, V. & Eze, O. R (2013). Effect of bank lending rate on the performance of Nigerian deposit
money banks. International Journal of Business and Management Review, 1(1), pp. 34 - 43.
Olagunju, A., Adeyanju, O. D. & Olabode, O. S (2011). Liquidity Management and Commercial
Banks’ Profitability
in Nigeria. Research Journal of Finance and Accounting, 2 (7/8), pp. 24 – 38.
Olaniyi, T. A. & Olabisi, O. Y (2011). Causes and impacts of global financial crisis on the
performance of Nigerian banks (a case study of selected banks). Journal of Business
Management and Economics, 2(4), pp. 164-170.
Olokoyo, Felicia Omowunmi (2012). The Effect of Bank Deregulation on Bank Performance in
Nigeria. International Journal of Advances in Management and Economics, 1(5), pp. 31 – 36.
Olowu, D. & Okotoni, O. (1996). The informal sector in Nigeria: Some analytical and
developmental issues. In Conceptual and methodological framework for informal sector
research in Nigeria, CBN/NISER Informal Sector Study, pp. 27 – 40.
Omorukpe, R.O (2003). Dictionary of financial accounting terms. Benin City: Mindex publishing.
Oresotu, F. O. (1996). Linkages between macroeconomic policy environment and the informal
sector. In Conceptual and Methodological Framework for Informal Sector Research in Nigeria,
CBN/NISER Informal Sector Study, pp. 41 -62.

26
 Global Journal of Human Resource Management
Vol.1, No. 3, pp. 12-28, September 2013
Published By European Centre for Research Training and Development UK (www.ea-journals.org)

Osamor, I. P., Akinlabi, H. & Osamor, V. C (2013). An Empirical Analysis of the Impact of
Globalisation on
Performance of Nigerian Commercial Banks in Post-Consolidation Period. European Journal of
Business and Management, 5(5), pp. 37 – 45.
Portes, A. & Schauffler, R. (1992). The informal economy in Latin America: Definition,
measurement and policies. Programme in Comparative International Development Working
paper No 5, Department of Sociology, John Hopkins University, Baltimore MD 21218 USA.
Rostow, W. W. (1960). The five stages of growth: A summary. In The stages of Economic Growth:
A Non-Communist Manifesto. Cambridge, Massachusetts: Cambridge University Press, pp. 4-16.
Smith, P. (1994). Assessing the size of the underground economy: The Canadian statistical
perspectives. Canadian Economic Observer, Catalogue No. 11-010 (3), pp. 16-33.
Soludo, C. C (2004). Consolidating the Nigerian Banking Industry to Meet the Development
Challenges of the 21st Century. Being an address delivered to the Special Meeting of the
Bankers’ Committee, held on July 6, at the CBN Headquarter, Abuja.
Somoye, R.O.C (2008). The Performances of Commercial Banks in Post- Consolidation Period in
Nigeria: An
Empirical Review. European Journal of Economics, Finance and Administrative Sciences, ISSN
1450-2275,
Issue 14.
Tanzi, V. (1983). The underground economy in the United States: Annual estimates, 1930-1980.
IMF Staff Papers, 30(2), pp. 283 – 308.
Tokman, V. (1978). Informal – formal sector relationships. CEPAL REVIEW First Half of 1978, pp.
99-134
Uboh, G.A.T (2005). Selected Essays on Contemporary Issues in Nigerian Banking System. Ibadan:
University Press PLC.
Uremadu, S. O (2012). Bank Capital Structure, Liquidity and Profitability Evidence from the
Nigerian Banking System. International Journal of Academic Research in Accounting,
Finance and Management Sciences, 2 (1), pp. 98 – 113.
Wood, F. & Sangster, A (2005). Business Accounting 2, Tenth Edition. London: Pearson Education
Limited.
Yusuff, O. S. (2011). A theoretical analysis of the concept of informal economy and informality in
developing countries. European Journal of Social Sciences, 20(4), pp. 624 – 636.

* E-mail of the corresponding author: jonathan.ogbuabor@unn.edu.ng

27